If you know that it’s time to form a legal structure for your business, you probably have several questions about the process. Here’s a quick primer on incorporating in the U.S. Here’s the when, where, and how.
What’s the best business structure?
The perfect legal structure is going to depend on several factors, including how many legal formalities you want to deal with, how you want to raise capital, and how you want to be taxed. In the U.S., the three most popular business structures are the LLC (Limited Liability Company), S Corporation and C Corporation:
- LLC: Form an LLC if you want legal protection, but minimal formality. Corporations have to contend with administration demands like meeting minutes and filing addendums for any change. But an LLC has far fewer paperwork requirements, while still limiting the liability of the owners. An LLC does not file its own corporate taxes. Instead, the company’s profits and losses are passed through to the owners and reported on their personal tax returns.
- C Corporation: In the majority of cases, a C Corporation is overkill for the small business or freelancer. As mentioned above, operating as a C Corp requires a good deal of legal paperwork and formalities. In addition, a Corp is taxed separately and the company must file its own tax returns. This can lead to the problem of ‘double taxation’ where both the company and the company owners must file and pay taxes. However, a C Corporation should be used for those businesses that plan to reinvest their profits back into the company, seek venture capital funding, or go public.
- S Corporation: An S Corporation begins as a C Corp and then the owners submit paperwork to the IRS to be treated as a pass-through entity. This means that like the LLC, an S Corporation does not file its own taxes. Be aware that not every business can qualify to be an S Corporation. For example, an S Corporation cannot have more than 100 shareholders and shareholders must be U.S. citizens or residents.
What’s the best state for incorporation?
Delaware, Wyoming, and Nevada are three popular states for incorporation in the U.S. That’s because Delaware offers flexible, pro-business statutes, while Wyoming and Nevada feature low filing fees, as well as no state corporate income, franchise, and personal income taxes.
However, as a general rule of thumb, if your business will have fewer than 5 shareholders, you should incorporate in the state where you actually live or your business has a physical presence, such as an office. If you incorporate in a different state, you’ll need to deal with added fees and paperwork since you’re considered “operating out of state.” And for the small business, it’s just not worth it.
How do I incorporate or form an LLC?
There are three common methods for incorporating or forming an LLC. Each has its own unique advantages and disadvantages depending on your needs:
- Do-it-yourself: DIY is the lowest cost method, but you’ll need to do everything yourself. In short, you’ll need to submit the incorporation forms to your state’s secretary of state office. This is the best option is you’re more interested in saving money than time. You have to be able deal with lots of details and arbitrary rules.
- Online legal filing service: This next option is slightly more expensive than DIY. An online legal filing service will complete and file the documentation for you. Like any legal document, the articles of incorporation and application are full of tedious details (for example, some states have specific requirements about paper size and ink color!). A professional service can make sure that your application is done right and processed smoothly.
- Lawyer: This is the most expensive option, but may be necessary in certain situations. For example, if you have complex requirements for how your stock should be allocated or you are working with millions of dollars, then you should turn to expert advice.
When is the best time to incorporate?
In most cases, it’s best to incorporate or form an LLC as soon as possible. After all, the main benefit is liability protection and by waiting to incorporate, you can be exposing yourself to liability.
The act of incorporation or LLC formation won’t break the bank, particularly if you use an online legal filing service or file the forms yourself. It’s an important step in protecting your personal finances and growing your business.