Is Incorporation the Best Choice For a Small Business Startup?

A small business startup owner wondering about business structures and the best place to register the business has to consider the big picture as well as immediate concerns.

Is Incorporation the Best Choice For a Small Business Startup?

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As far as the business structure is concerned, the choices are pretty simple. It can be a sole proprietorship owned by a single founder, or a partnership if there are two or more founders.

Choosing to register it as a limited liability company (LLC) is advantageous in certain cases, since the personal liability of the business owner is limited, and does not extend to personal assets.

An incorporated company offers not just protection from liability, but also the structure that will be required if the startup grows fast and has to be scaled up quickly into a large company with lots of employees.

In terms of taxes, the main difference about a corporation in comparison to the other structures is that it does not offer pass-through taxation. So while sole proprietors and partnerships must show the profit as personal income on their returns, the corporation gets taxed at the corporate tax rate and then the stock holders will be taxed on the income they earn through wages, dividends and bonuses.

However, incorporation is still a better choice since the corporate tax rate is likely to be much lower than the personal income tax for your tax bracket.  Bottomline – if you think your startup has a good chance of growing big, and you can handle the compliance issues associated with setting up a corporation, then incorporation is the best choice.

Where to Incorporate

This brings us to the location. It’s not essential that you have to incorporate in the state where you plan to do business and/or where you reside. You could easily incorporate the business in tax-advantaged and business-friendly states such as Delaware or Nevada, and do business in your home state and anywhere else you want to.

Of course, this does mean you have to bear the cost and hassle of registering in Delaware and then again in your home state as an out-of-state corporation. A simple small business with 1-2 employees will find the compliance and costs of one incorporation hard enough, and adding one more on top of that makes it a wee bit too much.

This is a classic conundrum, because you don’t want to take on any burdens on your resources until the business is doing well. On the other hand, it’s very difficult, expensive and disruptive to your business if you switch your registration to another state afterwards.

So what should you do? Figure out the total costs, and see if you can afford it. For example, a general corporation or LLC in Delaware costs around $240. This includes the state filing fee of $139 and the registered agent’s fee and other processing charges.  Add this to the incorporation costs for your home state.

Consult with a business law expert or CPA to find out what you have to do in terms of compliance. If you think the costs and hassles are manageable, go for it because the incorporation will ensure continuity for your business as it grows.

About Richard Rosa

Richard A. Rosa is a CPA and also has recently taken up blogging, offering weekly updates about tax law, accounting news and analysis at Tax Law Blog