To Incorporate or Not to Incorporate - That is The Question

There are a number of possible benefits to incorporating a business or forming a Limited Liability Company (LLC), including personal asset protection, business credibility, and possible tax advantages.

Incorporation also offers greater confidentiality as to who the investors, officers, and all but the initial directors are than other business formations. However, you must follow corporate formalities after incorporation to maintain the “corporate veil” of protection and benefits of incorporation or LLC formation or they can be lost.  There are possible downsides to incorporating also, which should be considered.

Factors to Consider

Limiting Potential Personal Liability

Limiting potential personal liability of investors or owners is often the biggest consideration favoring incorporation or LLC formation.  These two entities limit the exposure to liability of investors or owners for business debts or liabilities to the amount invested and protect other personal assets of the investors from those debts.

The advantage to be gained from this will not be the same for every business, though.  The value of this protection depends on the type of products or services your business offers, the number and type of employees, and potential liability from your business activities.  A business with employees or products that could cause substantial harm to people or property may want more protection from personal liability than even liability insurance can offer.

Protection of personal assets, other than your investment in the corporation, from business debts of the corporation can also be very valuable.  These would be reasons to incorporate.  However, frequently banks or other lenders will require personal guarantees from owners unless the corporation or LLC has substantial assets and proven credit history.

Costs of Incorporation or LLC Formation

A fee will be payable to the Secretary of State to incorporate (generally around $350 in Texas), and attorney’s fees and accounting fees likely will be required to get your corporation set up properly.  Initial capital will have to be paid in to properly form the entity (usually $1,000 in Texas).

Income Taxation

This can go both ways—pro and con incorporation.  Corporations are separate tax entities, and the taxes on a corporation may or may not be greater than taxes for a company that is taxed at the owner's personal rate. Even though incorporated, your business can make a “Subchapter S” election, which allows income and losses to flow through to the individual shareholders.  


Whether this is smart or not requires wise counsel.  You should consult with your tax advisor to make sure you understand the tax implications before incorporating.  LLC’s are not strictly “corporations”, but are “pass-throughs” of income, like a partnership and have completely different tax considerations that a regular corporation.  Again, you should discuss with a trusted tax advisor whether an LLC or general corporation is the better way to go for your business.

Managing Income As Your Business Grows

As your business grows, if may be advantageous for you to take business income in through the corporation and pay yourself a salary rather than showing the income as yours personally in a sole proprietorship.  This is one case where a corporation is preferable to an LLC (an LLC is taxed at the personal tax rates of the owners). Timing is important, so if you think you might be making a lot of money in a particular year, you may want to switch to a corporation or S corporation rather than a sole proprietorship or LLC.

Franchise Taxation

Texas franchise tax is figured as .25% of net taxable capital and 4.5% of net taxable earned surplus each year of operation.  If the amount computed under either part of these tests is zero, no tax is due. If the franchise tax computed is less than $100, the corporation is not required to pay such amount and is not considered to owe any franchise tax for the period.  Franchise taxes are not due from sole proprietorships so this is a consideration in whether or not to incorporate.

Conclusion

You should review all the pro’s and con’s of incorporation or LLC formation with trusted legal and tax advisors before making the commitment to go forward and be prepared to follow through on the legal requirements to keep the legal protections these alternatives provide.

Adair Buckner would be happy to consult with you on making this important business decision. 

Please call 806-220-0150 or email her at adair@adairbuckner.com to set up a free consultation.

Adair M. Buckner, Attorney at Law, is Board Certified in Labor and Employment Law by the Texas Board of Legal Specialization.


Her other areas of practice include business law, business disputes, commercial litigation, estate planning, and probate.


You can reach Adair at (806)-220-0150 or adair@adairbuckner.com.


This material is not intended to be legal advice. The contents are intended for general information purposes only.

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