Choosing the right type of entity for your business is a critical decision that can have long-lasting ramifications in terms of taxes and personal liability. It is not unusual for those starting a business for the first time to have some misconceptions about incorporation; here are the top five:
Myth #1: Incorporation helps avoid state income taxes. No matter what state you incorporate your business in, you will still be liable for state income taxes if you operate your business in a state that requires businesses to pay state income taxes. For example, if you incorporate in Nevada, which has no state income taxes, but operate your business in California, which does, you will still be paying California state income tax. For small businesses, it is often best to incorporate in the state where you do business. If you are truly virtual, it may make sense to incorporate in a State without state income taxes, but you’ll need to do it right, so contact us before you do.
Myth #2: Incorporating automatically protects you from personal liability. Personal liability protection is one advantage of establishing your company as a corporation or limited liability company (LLC). However, you can still be held personally liable in certain situations — for example, if you sign a contract using your own name, do not maintain the appropriate compliance paperwork, personally guarantee a loan or commit a crime. Once you do incorporate, be sure to sign all legal documents in the name of your business entity, not in your name personally.
Myth #3: Corporations are eligible for more deductions. Business expenses that are ordinary and necessary are deductible, whether the business is a sole proprietorship, LLC or corporation. While incorporating can save business owners in terms of self-employment and payroll taxes, corporations are not eligible for more deductions just by virtue of the fact that they are corporations. One thing to be aware of though is that incorporating as an LLC and being taxes as a partnership or sole proprietor may result in more self employment and payroll taxes than incorporating as (or being taxed as) an S-Corporation. Contact us to discuss specifics.
#4: You can wait to make a decision. Many entrepreneurs believe they do not need to incorporate before their product or service is ready for market, but incorporating early can provide necessary personal liability protection since liability issues can arise before a product hits the market. It can also be a benefit to incorporate early if you hope to sell your business, since you have to hold the stock from more than a year to be able to treat the proceeds from the sale as long-term capital gains instead of ordinary income. Most importantly, incorporating early gets you serious about your business and that creates success faster than anything else.
Myth #5: You can shelter income in a corporation. Fledgling business owners may think they can shelter income by keeping cash inside a corporation. However, a corporation must pay income taxes on that income and when the owner eventually takes the profits out through dividends, taxes must be paid on his or her personal return. This “double taxation” issue is why many small business owners choose an LLC or S Corporation structure.
Whether you’re starting or already running a business, the best time to hire a lawyer is before you need one. Having a business attorney that understands the individual needs and unique circumstances of your company is key to helping your business thrive and prosper. If you are interested in learning more about legal protection strategies for your business and how we work with you as a partner in protecting your company, contact a Creative Business Lawyer® to schedule your comprehensive LIFT™ (legal, insurance, financial and tax) Foundation Audit.