NEW YORK (AP) - It might have crossed your mind as you stapled ScheduleC into your individual tax return -- should you turn your smallbusiness into a corporation? And what benefits would that bring you andyour company?
Generally, small business owners face two major considerations indeciding whether to incorporate -- limiting their liability forcorporate debts including court judgments, and gaining the mostfavorable tax treatment for themselves and the business. Some also findthemselves thinking in terms of a corporation when they decide to seekoutside investors or bank loans.
John Gordon, whose company helps businesses incorporate, said liabilityis the primary reason for owners to choose a corporation, particularlyif they have employees.
"If you're a sole proprietor and people are going around doing thingsin your name for which you're personally liable, you really shouldconsider incorporating," said Gordon, president of USA CorporateServices Inc. in Albany, N.Y.
But in recent years, a newer business entity called the limitedliability company has emerged, offering many of the benefits ofincorporating but with a looser operating structure. While state lawsrequire corporations to have a three-tiered organization that includesshareholders, directors and managers, an LLC is more like apartnership, creating its own management structure.
LLCs generally have the limits on liability that corporations do, andthe option to be taxed as partnerships. Many small company owners are opting for the LLC, and Gordon predictedthat as more people become more familiar with the concept, LLCs willbecome even more common. For many owners, a corporation is the last step in a progression ofentities that grow more complex along with the company itself,according to Anthony Mancuso, an attorney in Berkeley, Calif., andauthor of books includingForm Your Own Limited Liability Company (Nolo.com) and Incorporate Your Own Business(Nolo.com, 2002). Mancuso said companies tend to move from sole proprietorships to LLCsas concerns about liability arise, and then to corporations whenthey're looking for outside money. He said banks and investors preferthe structure of a corporation to the often more nebulous organizationof a partnership or sole proprietorship. "They're not as comfortable as they are with a board of directors,"Mancuso said. And incentives such as stock options and stock ownership for employeesare possible only with a corporation, he noted. The issues raised by the various business entities can be very involvedand probably should be discussed with an accountant or attorney todetermine what kind of organization would most benefit a particularsmall business and its owner, if the company is a sole proprietorship,or its owners, if it's a partnership.
Tax issues can be particularly difficult. Generally, with a sole proprietorship, partnership or LLC, the businessprofits are all passed through to the owners, and they pay the tax. Oneof the benefits is that there's only one tax -- unlike a corporation,where a tax is levied first on the profits and then on the dividendspaid to shareholders. But while that double tax is often seen as a downside, the corporatetaxation process can be more advantageous in that it allows profits tostay with the corporation rather than be paid out. That gives acorporation capital for expansion and acquisitions, and very smallcorporations get an added benefit in that the lowest corporate taxrates are less than the lowest tax rates on individuals. Moreover, in small corporations, the shareholders often are officers aswell, and profits tend to be paid out in the form of salaries and otherbenefits that are deductible to the corporation. It should be noted, however, that it is possible for an LLC to chooseto be taxed as a corporation, which might make it a more attractivealternative for some businesses. Also, some corporations, called Scorporations after an Internal Revenue Code provision, are taxed in amanner more like an LLC than traditional corporations (which are knownas C corporations).
Another possible negative in a corporation is that it is required bylaw to have a more elaborate structure than other entities and also canbe more complex to run. State laws generally require paperworkincluding articles of incorporation and bylaws, governance proceduresincluding periodic directors' meetings at which minutes must be takenand annual shareholders' meetings. Of course, for many small companies with few directors andshareholders, these can be fairly simple gatherings because the samepeople often fill several roles at once -- officer, director andshareholder. Associated Press iSyndicate, Inc.
