Should My Small Business Incorporate?

In Ohio, this will depend on a few factors

By Doug Mentes, Esq.

Not all small businesses—defined as employing 500 or fewer employees—incorporate. Many remain sole proprietorships, which don’t require registration with the state of Ohio. In fact, the U.S. Small Business Administration reports that small businesses in the U.S. make up 99.9 percent of all businesses, and 80 percent of those small businesses have no employees. And for those businesses that have no employees, 86 percent are sole proprietorships.

Why incorporate?

The most widely agreed-to advantage for incorporation is to obtain limited liability. Generally, this means that an owner’s liability is limited to the owner’s investment in the corporation; because the incorporation creates a new legal entity, creditors cannot get to an owner’s personal assets or savings.

With a sole proprietorship, creditors can seize personal assets—such as savings or a home—to pay the business’s debts. If the business is incorporated, however, owners have no risk of personal responsibility for corporate debts and obligations—unless an owner commits fraud.

Creation of the new legal entity leads to other benefits, as well:

  • Unlike proprietorships and partnerships, the life of a corporation is not dependent on the life of any individual. Owners can leave, and the corporation can continue
  • Ownership interest is represented as shares of stock in the business, and shares can be easily sold, transferred or gifted
  • You can attract new owners or investment in the business by selling shares of stock
  • Customers, vendors and suppliers may see greater value in doing business with an established corporation

Potential disadvantages

With some corporate structures, business owners may pay more in taxes. The IRS defines corporate structures as either C corporations or S corporations, and, although Limited Liability Companies (LLCs) are not corporations, they are similar in structure.

Generally speaking, under the C corporation structure, income is taxed at both the corporate and individual levels. For example, income to the business is subject to corporate income tax, and if that income is then distributed to owners or shareholders, it is taxed again as personal income. This potential double-taxation is avoided under the S corporation and LLC structures, which allow corporate income to pass directly to the individual shareholders, where it is then taxed as personal income.

Incorporation further requires much more record keeping and paperwork than a proprietorship. While it’s simple to visit the Ohio Secretary of State’s office’s website and file the necessary documents to get a business registered, the corporation must file its own tax return each year and keep records of meetings and decisions.

Truly small businesses may be unable to take advantage of the benefit of limited liability because creditors will require personal guaranties until the corporation itself has assets and can build up its credit. Further, irresponsible decision making could eliminate the corporate protection of limited liability. Owners who use the corporate structure to engage in fraud can lose that protection when a court pierces the corporate veil to get to the owner’s personal assets. Owners who defraud creditors, or mix their personal finances with the corporate finances, are the most common types of offenders.

Incorporation is not for the unwary. Although simple to set up, it’s likely of little benefit without weighing the benefits and costs to your business with an expert. Business owners considering incorporating should sit down with an experienced Ohio business law attorney before making such a decision.

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