Do I Need to Incorporate My New Venture?
As an artist, author, freelancer, contractor or individual who has a cottage business, you may have asked yourself: Is there an advantage to incorporating my business?
First off, you may not be aware that the state or county where your business is based likely has requirements regarding registering to transact business – even if you operating your business as a sole proprietor under your own name. For example, if you were running your business as John Smith Attorney at Law, your state or county may require you to place a printed advertisement for a certain period of time and legally register your business name. These laws were put in place a long time ago to protect the public from shady operators and to protect you in case another business tries to use your business’s name.
To determine the best course of action, you will need to analyze and understand the types of entities of incorporation and the benefits and the drawbacks of each. If your business operates in multiple states, you’ll also need to assess the rules each state has for incorporation in order to select the right one for establishing your company’s charter. to determine the optimal one for you and the best State to provide your company charter.
When should I incorporate?
If your venture currently meets the following criteria or will in the next twelve months then incorporation will make sense.
- Will you have investors in the business or multiple owners?
- Will your business have over $10,000 in sales?
- Will your business generate over $5,000 of profit?
- Will you get credit from vendors for inventory?
- Will you be selling a product or service that exposes you to a product liability claim?
What state should I incorporate my business in?
If you say yes to any of the above I suggest looking at incorporating. A small hobby business with little income may not make sense to formally incorporate, given you will have costs associated with filing for the corporation and filing another tax return. State filing fees run around one hundred to three hundred dollars. Your new corporation will require a tax return even if all of the income passes through to you. Think through these costs and make sure that the business can support the additional expenses you will have with incorporation.
My opinion is incorporate in your home state. A company located where you live and pay taxes it simple. Certainly, if you are the only employee and your do most of your work and reside in that state then your choice of where to incorporate is simple. If you begin to have significant recurring sales in another State or plan to open an office, you can then choose to get your company qualified to do business in that state or set up a subsidiary in that State.
Most states require a local address for your corporate entity. That means if you set up in a state you do not reside in, and you don’t have an office in that State, you will need to go through an agent that acts on your behalf in that State.
You may have heard about Nevada and Wyoming as states that have special limited liability companies that offer added protections for your assets. While they might make it harder for someone to identify you as the owner and have some variation in corporate laws from your home State they won’t protect you if you break the law by hiding assets or shirk tax liabilities. A determined tax agent will eventually find them and you.
Delaware is also a very common location to incorporate a business. The state laws are favorable to companies and corporate protection. The “First State” is an excellent choice if you are planning to go national and take other people’s money for investment. If this is the case, I suggest you seek to a lawyer familiar with corporate structuring to help set up the appropriate structures and provide the necessary documents (i.e., Operating Agreement, Private Placement Memorandum). Doing this right the first time will bring credibility when you are out raising money and when investors begin doing diligence on your company.
Determine the Best Type of Structure
- • Sole Proprietor
- • Limited Liability Company LLC
- • Corporation Subchapter C or S
- • Limited Liability Partnership LLP
Whether you register or not, you are a sole proprietor in the eyes of Uncle Sam if you sell four hundred dollars or more on your own. You are expected by the IRS to claim the income on your personal income tax. It is likely that there are county and state regulations to registering as a sole proprietor to legally do business.
DBA Doing Business As
If you plan to do business under another name “Doing Business As” (DBA) you need to register your business name and advertise that you will be doing business under an assumed name.
You will need to record the Business with the state or county to conduct business. In Illinois, if you are a sole proprietor/ individual and looking to register a name to do business under you register with the county clerk
or if you are seeking to do business under another name (DBA) you will need to register that name in with the same Clerk. The fee runs around $50-110.
You will need to:
- Registration with County or State
- Advertising your DBA for one month in approved newspapers.
Your registration protects you from others using the name.
Limited Liability Company (llc)
A limited liability corporation provides an independent entity. It provides flexibility with how you want the membership to work, share profits and operate. All of the ins and outs should be documented in an operating agreement. You don’t need an operating agreement if you are a single member LLC or two members that are husband and wife.
The liability that is limited is your obligation for debts incurred by the LLC. Unsecured debtors have limited recourse if your LLC goes bankrupt. A note of caution, if you personally guarantee loans for the LLC, you will have the liability so beware.
In a LLC, all profits get passed through to partners. Profits will be taxed at the member’s personal income tax rate and will need to include self-employment taxes. Be sure to allocate the cash to pay the taxes. If you reinvest the profits, and there is no cash you will have to reach into your pocket to pay the taxes. See more in the taxes section of Business owner’s Compendium.
If you have multiple members, you need to have an operating agreement. I guarantee if you don’t, you and your partners will be at odds with how to distribute profits or who has certain rights over others. Operating Agreements are also important in situations where one partner is passive and may be contributing capital, and the other partner is more active and contributing less capital. Hash out the details before the profits roll in.
Articles of Incorporation
Articles of Incorporation are a simple document from the state that shows that the business is incorporated, the type of incorporation, and the purpose of the firm.
A state requires a renewal fee and a filing to keep records up to date and your llc in good standing. If you do not do so the state will cancel the charter and the entity will no longer exist, losing all of the protections that it provides.
If you choose to close an llc be sure to file a final return and to file with the state that you are suspending the charter.
CORPORATION C & S
Some differences on Corporations. First Corporations pay a corporate tax rate on profits unless the Corporation is Subchapter S. Corporate taxes create a double taxation where there are taxes paid on corporate profits then again by shareholders on dividends.
Corporations also have stricter rules around distribution on profits. Retained Profits increase shareholder equity equally and profits that are distributed go out as dividends. The Profit is split equally across the shareholders of the same types of stock. There can be different stock classes that have various rights and payment priority but in the case of a company with just common stock dividends are split equally and those shareholders.
One benefit is that a corporation can employ owners. You can draw a salary and be treated like any other employee.
If you elect to have your corporation set up as a subchapter-S, then the company’s profits flow to the shareholder’s tax returns. There are limits to the number of shareholders (100) and who can be shareholders when you can elect to be a subchapter S.
As an S corp, you get the ability to collect a salary with a W-2. An advantage if you are self-employed as it becomes difficult to qualify for car loans and home mortgages when you are self-employed. As a W-2 employee, that little piece of paper ticks the right boxes for most lenders.
Once your company is making money, you have some added tax advantages (within reason) as a self-employed single employee in an S corp. You can optimize your salary level and profits to lessen your tax burden.
By setting a lower salary that accrues lower payroll taxes and allowing the rest flow out as profits that do not attract payroll taxes like an LLC, you will have a lower overall tax burden and eliminate the second taxation on profits. Be careful for decades, many have thought they would play games and run small salaries to keep the payroll taxes down. The taxing authorities at the State and Federal level have seen this and every other trick and will fine you and collect back taxes on what they determine should have been salary. A rule of thumb is your salary should run at levels paid to a non-owner doing the same role or 50% of the company’s profits. As the single employee in the early days, 50% of the profits may not cover a month of your mortgage but you are setting the habit of paying yourself. Later when your company makes a million dollars a year a $500,000 salary may be excessive for the role, but it is an easy sell to the tax man as appropriate given the level of profits.
Your Corporation must have by-laws that deal with the election of the board. Shareholder rights, and frequency of board meetings. Most States require board minutes and an annual report filed with the State. The annual report will have limited disclosure requirements with a focus on who is on the Board.
To elect to be a Sub Chapter S you are required to fill out a form with the IRS. I suggest you do this immediately:
BENEFIT CORPORATIONS or B Corp
This legal classification falls along the same lines as an S Corp, C Corp or limited liability company. Twenty-seven states and the District of Columbia recognize and charter benefit corporations. Benefit corporations function almost identically to S and C Corps, with two differences;
1. The corporate charter must include social good.
2. A benefit corporation must comply with a third-party standard that measures corporate social responsibility.
This does not create a tax exempt certification and the business is required to pay appropriate taxes on profits. What is different is that there is clarity around the social or environmental benefit of the company and that this social benefit may take precedence to the profit motive of most firms.
CERTIFIED B CORPS.
This is a certification awarded to businesses that pass B Lab’s social responsibility assessment. Certified B Corps must retake the assessment every two years, and each year, 10 percent of certified B Corps are audited in person.
Limited Liability Partnership LLP
Some States have LLPs for Professional Partnerships (i.e. Lawyers, Engineers, Accountants). The corporation is also used sometimes for Investment firms that are doing venture capital or Private Equity.
Most states have a process and fee for getting foreign corporations qualified to do business in the state. Typically, you need to fill out a form, pay a filing fee and provide a certificate of good standing from the State where the entity is chartered. Most sites allow for you to do this all electronically although there are others that require you to wait before doing business until your qualification is approved.
File and Pay Fees
When it comes to filing, you can do this a couple of different ways. I am of the opinion that if you are running a small business that you are the only employee, you should do it yourself and save the money that it would cost to have someone else do it. That being said here are the options
You can hire a lawyer that will file the appropriate documents. You will pay the filing fees and for his or an assistant’s time to file.
There are dozens of sites that will incorporate your business they are for-profit businesses, and there will be additional charges along wit the filing fees. In some cases, they can also act as an agent if you are out of state
There are still brick and mortar facilities that will do the filing for you and act as the agent for your business if you need this service.
If you are a single member or a husband-wife relationship where a partnership agreement is not going to be put in place you can set up the entity yourself. I have done this several times as well as dealing with all the renewals and filings for my LLC. In most states, this can be done online, and you will get your articles of incorporation in less than 48 hours.
Links to your incorporating by State
Here are links to State websites where you can electronically file for incorporation, they are all direct to the State regulator that handles registration for that State. I am not recommending these above others, you can always use other sites but they will typically charge a fee above the filing fee.
New Hampshire: http://sos.nh.gov/Corp_Div.aspx
New Jersey: http://www.nj.gov/njbusiness/
New York: https://www.dos.ny.gov/corps/
North Carolina: https://www.sosnc.gov/corporations/printforms.aspx
North Dakota: http://sos.nd.gov/business/business-services
South Dakota: https://sosenterprise.sd.gov/businessservices/
West Virginia: http://apps.sos.wv.gov/business/corporations/
Get a Tax ID for the business separate from your social security number
Once you have your articles of incorporation you can set up your Employer Identification Number (EIN). Think of it as your corporation’s social security number. You can apply for this online, and it is free. You will need it for filing returns and for identifying your business to suppliers and customers. Anyone that is getting royalties or commissions will typically be required to fill out a W-9 and need to provide an EIN or social security number
1. Have a company name: Make sure you’re happy with it because you will pay a fee to change it later.
2. Have an office address for your company.
3. Have details on Managing Members or Board Members including social security numbers and home address for the filing
4. Select the State of Incorporation
5. Research that State’s options for entities
6. Have a credit card if you plan to file online
7. Select a LLC, Corporation or LLP
8. Save your Articles of incorporation
9. Get and EIN number from the IRS
10. Make your dreams come true