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Incorporation: Frequently Asked Questions

The following questions were submitted by Staples.com users like you. Business law expert, Steven Strauss, replied with the following answers.

Is incorporation necessary?

Q: I am thinking about investing in buying homes for resale with another party. Should we incorporate to do this?



A: There are pros and cons to incorporating in a situation like this. The obvious benefit is that by incorporating, you greatly reduce, and practically eliminate, your personal liability for the transactions. If one of the houses later proves to have problems, it is your corporation, and not you, who could eventually be liable. Protecting your assets is a great reason to incorporate.

The bad news is that it is not cheap. Hiring a lawyer and filing the paperwork can easily cost $2,500. If cost is not a factor, then I say do it. If a disgruntled homebuyer ever sues you, you will be very happy you did.

What kind of corporation is best?

Q: I want to incorporate my new business. What kind of corporation is best?



A: There are three types of corporations: S corporations, C corporations, and limited liability companies (LLCs). The problem with a C corporation is that it is taxed twice: once when the business makes a profit and then a second time when those profits are distributed to shareholders. S corporations avoid this by passing all tax liabilities onto shareholders. As such, S corporations are only taxed once. The same is true for an LLC.

So which is best for you? That depends on what type of business you're starting. If you plan on creating a large company (one that is publicly traded), you must choose a C corporation because shares of its stock are most easily transferred. While you might want an S corporation for tax reasons, they are limited to no more than 75 shareholders, all of whom must be individuals. LLCs trump S corporations since they have no limit on the number of shareholders, and those shareholders can be corporations and partnerships. Generally speaking, LLCs are best for smaller startups and C corporations are best for larger ones.

Sole proprietorship, partnership, LLC, or corporation?

Q: I'd like to start my own business and, at least in the beginning, keep my daytime job. I'm wondering which is the best business structure to suit me: a sole proprietorship, a partnership, an LLC or a corporation?



A:  A sole proprietor ship is the easiest, least expensive way to start a business. Simply get a business license from your city or county, hang your shingle, and you are in business, literally. Sole proprietorships are great because you have no one to answer to but yourself.

A business partnership is a lot like a marriage. You need to pick a good partner because you will be spending a lot of time together and trusting each other. Legally speaking, this is where a partnership differs the most from a sole proprietorship. Each partner has the legal right to make decisions and enter into contracts on behalf of the whole partnership. The danger is that your partner may make some ill–advised decisions, get the partnership into debt, and you will be personally responsible for that debt.

Partnerships on the other hand, although more complicated, have the added bonus of giving you someone to bounce ideas off of and another pair of hands to get the job done.

Besides partnerships and sole proprietorships, the other main way to form a business is as a corporation. There are three types of corporations — C corporations, S corporations, and the Limited Liability Corporation (LLC).

The best thing about forming your business as a corporation is that it limits your personal liability, which is not true for partnerships and sole proprietorships. For example, say that you owned a tire shop, that one of your employees negligently installed a tire, and that the tire fell off the car and caused a three–car accident, including several personal injuries. If your tire store was not a corporation, the injured parties could come after you personally for money damages. This means that you could lose your business, your house — everything.

That would not be true if you incorporated. Creditors are limited to the assets of the corporation only for payment and may not collect directly from the shareholders.

Another issue to be aware of is taxes. C corporations are taxed twice. First, the corporation is taxed on net income, and second, shareholders are taxed on the income that they receive from the corporation. (Who said the IRS is getting friendlier?) S corporations avoid this by passing the tax liability onto shareholders. As such, S corporations are only taxed once. The same is true for an LLC.

So which is best for you? If you plan on creating a large company (one that is publicly traded) you choose a C Corp because shares of stock are most easily transferred. While you might want an S corporation for tax reasons, they are limited to no more than 75 shareholders, all of whom must be individuals. LLC's trump S Corps since they have no limit on the number of shareholders, and those shareholders can be corporations and partnerships. Generally speaking, LLC's are best for smaller start–ups and C corps are best for larger ones.


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