When I started my Internet marketing company, I faced the same choice made by most business owners: How should I structure my company?
While many business owners default to operating as a sole proprietorship because that's the easiest option, I knew from my legal background that there were a number of different business entities to choose from. Ultimately, I decided the best approach was to operate as an S-corp, so I filed papers with the state and my notifications to the IRS, and my corporation was born.
Here are three key reasons I decided operating as an S-corp was the way to go.
1. Operating as an S-corp provides protection from liability
An S-corporation is a business structure that establishes the company as an entirely separate legal entity.
When you operate a business as a sole proprietorship, there's no separation between you and your company. If your business gets into debt or is sued, it's the same as you personally being sued or indebted. Once a business is incorporated, however, it's no longer an extension of you -- it has its own legal identity.
When you've formed an S-corp, your potential financial losses are limited to your investment in the business. While you have to follow the rules for maintaining a separate corporate entity -- such as not mixing personal and business funds -- your wealth is safe even if something goes wrong.
2. Operating as an S-corp provides tax flexibility
When you form a corporation, you can operate as a C-corp or as an S-corp. The "C" and "S" stand for the subchapters of the Internal Revenue Code.
Both C-corps and S-corps file their own tax returns separate from owners. However, they work differently. With a C-corp, the business pays taxes and owners are also taxed on business income, which leads to the potential for double taxation. An S-corp, on the other hand, is known as a pass-through entity. Profits and losses pass through to owners, who declare them on personal tax returns. Though the S-corp files a return, it doesn't pay taxes.
The benefit for S-corp owners, however, is that when income "passes through," it doesn't all have to be counted as ordinary income. While S-corp owners must pay themselves a reasonable salary if they're actively involved in managing the company, they can take some of the money out of the company as a "distribution." When income comes as a distribution, S-corp owners don't pay self-employment taxes on it, which brings significant savings.
3. Operating as an S-corp makes it easier to pass on the business
As an S-corp owner, I actually own stock in my company. While I can't sell the stock as easily as I could sell stock of a public company, I have the ability to transfer ownership by giving stock away or by selling it if I can find a willing buyer. This provides flexibility if I ever want to step away from the company but allow it to continue operating.
Incorporating a personal or family business is often a key part of business succession planning if you want your business to survive you. Since I've already done this, I won't have to worry in later years.
Incorporating doesn't have to be complicated
If you're running a business, consider incorporating as an S-corp if you want flexibility in how your income is taxed, protection from liability, and an easy way to transfer your company.
Incorporating doesn't have to be complicated. While the rules vary by state, typically it involves obtaining a tax ID, submitting Articles of Incorporation to the Secretary of State where you live, and filing an S-corp election form with the IRS. There's a small cost involved, and some states require you to take additional steps such as advertising your incorporation -- but the whole process can be completed quickly.
If you aren't sure whether to form a corporation or how to handle the process, an attorney can provide guidance and help you get your incorporation completed for a small cost.