What Are the Differences between Incorporated and Unincorporated Businesses?
As a business owner, you have several options when it comes to the legal structure of your business. Choosing the right model for your organization will depend on several key factors. How you feel about risk, any concerns you have about protecting your personal assets, and even the amount of paperwork you are willing to do can help you decide if an incorporated or unincorporated business is right for you. Incorporating is designed to protect you from risk, but may offer other appealing benefits as well. The type of business you operate, your goals, and even your need to protect personal assets will impact your decision. Learning more about incorporation can help you decide if this approach is right for you.
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What Is Business Incorporation?
Business incorporation creates a separate legal entity for your business. You may still be the owner, but by choosing this legal structure you can attain clear financial and tax-related benefits for your organization. When you incorporate your business, you choose one of several legal structures to operate under. You have several choices for incorporation depending on your current needs, your potential future needs, and even the nature of your business.
While you can choose an initial structure for your business, it can be changed as your organization grows and matures. A small business that starts as a sole proprietorship can later be formally incorporated once it grows. No matter which format you choose, incorporating has clear benefits for you and your new business.
The Benefits of Incorporation
Incorporation can help reduce the amount of risk you personally have to take on. From protecting you from personal liability to offering tax benefits, and even the ability to pass on your business to future generations, incorporating offers clear benefits to your business.
- Protection from personal liability – When you incorporate, you get protection from any personal liability your business creates, including debts and other obligations. If someone sues your business, in most cases they can only access your company’s assets. If you are not incorporated, your personal wealth, assets, and income could be in jeopardy. If someone is injured on your business property or while you are conducting business, your corporation can be sued, but in most cases your own personal assets, including your home, bank account, and other things you own, could be at risk.
- Benefits at tax time – When you incorporate, you may be able to gain several benefits at tax time. While you will need to speak with an accountant to find out exactly how your organization will benefit, you may be able to achieve a lower tax burden by incorporating.
- Separate your corporate identity from your personal identity – Incorporating makes your business a separate entity and separates it from you and your history. In some cases, an incorporated business could have more credibility with prospects than a sole proprietorship or an unincorporated entity. If you are using your personal name as your business name or have not taken steps to incorporate, you risk being seen as a hobbyist or overlooked when a potential client is looking for a product or service in your industry.
- Easier access to capital – As an incorporated business, you may find it easier to get the capital you need to grow. Corporations can sell corporate stock and securities to raise capital and expand. Even if selling stock is not in your plans, being incorporated can help other businesses, including vendors and suppliers, take your business more seriously. Whether you need to borrow money from the bank or want to sell stock and gain shareholders, you will need to incorporate first.
- Unlimited lifespan – An incorporated business exists in perpetuity; it can be sold, passed down to another family member, or otherwise disposed of. In most cases, your corporation will continue until you take steps to dissolve it. Some LLCs may have a limited lifespan, but it can easily be renewed as needed. If you have concerns about what happens when you are ready to retire or who will take care of your business when you are no longer willing or able to, then incorporation can give you peace of mind.
The Downsides of Incorporation
Like any decision you make for your business, you will need to carefully weigh all of the potential complications before you decide to incorporate. While incorporating often has more benefits than remaining unincorporated, there are a few consequences or disadvantages to be aware of.
- Complexity and paperwork – The initial process varies somewhat depending on where you live, but incorporation does require time, resources, and paperwork. Even after you incorporate, you will still need to keep excellent records and file tax returns for both your personal finances and your incorporated business. If you do not like paperwork or have trouble getting organized, the incorporation process could be a challenge.
- Costs – You will need to pay some fees when you initially incorporate, and you will have additional maintenance expenses along the way. If you are a cash-starved startup, the cost of incorporating can be a large burden. An LLC might still be an affordable alternative if cost is your greatest concern. The location of your business will have the biggest impact on your costs; each state has their own specific set of rules and fees about incorporation.
- Liability is not ironclad – While the purpose of a corporation is to limit your liability, your corporation can be challenged in some instances. If your corporation cannot secure a loan because you do not have enough assets, a bank may require you to use some of your personal assets as a guarantee.
The Differences between Incorporated and Unincorporated Businesses
Since an incorporated business becomes a separate entity from the owner, it can stand alone in the courts. If you run an unincorporated business, you, the business owner, bear all of the responsibility and liability for everything your business does. The biggest difference between an incorporated and an unincorporated business is the way the owners are held responsible for the actions and results of the organization. Some key ways that incorporated and unincorporated businesses differ include liability, taxes, costs, and paperwork. Learning more about the way these distinctly different business models operate can help you to make the best possible decision for your business.
- Liability – When you have an incorporated business, you, the business owner, are protected from any liability your business incurs. If your incorporated business fails to pay a debt and defaults, the creditor or vendor cannot come after your personal assets. If you are not incorporated and your business ends up defaulting or owing someone money, you are held personally liable for your debts. If someone files a lawsuit against your business and the entity is found to be at fault, your personal assets will not be available to pay any sanctions, fines, or payments required by the court. Just like with debts, if you are not incorporated, your own personal assets could be in jeopardy if you are taken to court and lose.
- Taxation – For most businesses, an incorporated organization will pay fewer taxes than one personally owned by an individual. Since an incorporated business can also defer some taxes and pay at a later date, you may have an easier time with cash flow. As a small business, if you are incorporated, you may also qualify for some additional deductions. When you are incorporated, you will need to file a separate business tax return along with your own personal tax return. An unincorporated business owner can file one single tax return. In addition to filing just one return, an unincorporated owner can claim some personal tax credits when it is time to file. As a business owner with an unincorporated business, you can also use any business losses you end up experiencing to decrease your personal tax liability and income.
- Initial and ongoing costs – While you will have some initial costs to set up your corporation, the exact amount you will need to spend will depend on the state you live in. Different states charge different levels of fees for filing articles of incorporation. In some areas, your costs could be as low as $60.00 for your initial filing. Once you file, you will have some regular and ongoing fees each year; the amounts will vary based on where you live and the regulations you need to follow. If you need legal help setting up your corporation, you may also incur additional fees and expenses. As a corporation, you may have ongoing maintenance costs and be required to maintain specific accounting records and to provide prepared financial statements as needed. In addition to these pieces of documentation, you may also have to pay for professional tax preparation and assistance. An unincorporated business owner may be able to take a more affordable, DIY approach.
- Paperwork requirements – As a separate entity, your corporation has some specific paperwork requirements that you do not have to adhere to if you are an unincorporated business. As a corporation, you will have to prepare both quarterly and annual reports for both regulatory and government agencies. Incorporated businesses have other individuals to answer to as well; for example, if you have a board of directors or shareholders, you will need to keep them up to date on your organization’s activities and financial status. From financial statements to annual reports, you will need to supply a steady stream of information to your shareholders. If you are not incorporated, you will not have to worry about most of these paperwork concerns.
- Legacy considerations – If the original owner retires, dies, moves on, or simply sells the business, an incorporated business can continue in perpetuity. If the business is unincorporated, you may have to take additional steps to sell or transfer your business.
- Brand perception – Taking steps to incorporate can help others, such as potential investors, financiers, your bank, or those you are targeting with your marketing efforts, take your business seriously. If you find you have difficulty being taken seriously, incorporating and becoming a separate entity can help.
Fully understanding the differences between owning and operating an incorporated business and an unincorporated one can help you to determine which model is right for you. If risk is a concern for you, then incorporating can help give you peace of mind and ensure that your own personal wealth and assets are kept safe from any liability your business incurs.
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