How to Incorporate Your Business – and Why
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Many people visiting our site are trying to answer the question, “How do I incorporate myself?”
The question that is really being asked is, “How do I incorporate my business?” In other words, how does one isolate their business into an entity that is separate from themselves personally.
On a technical level, you do NOT incorporate yourself — you incorporate your business. By doing so, you are able to separate your business liability from your personal liability.
By incorporating you create a new entity (your business), and that new entity will need to be classified as one of various forms. It can become an S-Corporation, a Limited Liability Corporation (LLC)*, a Professional Corporation, or a traditional C-Corporation.
While there are differences between them, all of these forms serve the purpose of bringing a business entity into existence, with the important result of insuring that you and your business are legally separate things.
*Please note that if you choose to form an LLC, doing so is called “formation” or “forming an LLC”, rather than “incorporating”. While the language used is slightly different, both accomplish the same goal.
Before we discuss the how part of incorporation, let’s address the more fundamental question of why to incorporate.
Incorporating for the Wrong Reasons
Many people hear about incorporating their business from advertisements, friends, or financial advisors. Unfortunately, these sources sometimes give the impression that incorporating is a savvy way to avoid payment of some taxes on your income, or to deduct personal expenses or lifestyle.
If your sole source of income is as a salaried employee working for someone else, you WILL NOT gain any tax advantages by incorporating, and you may in fact end up paying more in taxes. If this is your working situation, incorporating will only serve to add un-needed paperwork to your life.
Also, when filing tax deductions, NO ONE can ever deduct expenses that are not made during the ordinary conduct of business, or that are not reasonable to the conduct of your business. To do so is TAX FRAUD. Does this mean that people don’t knowingly or unknowingly take wrongful tax deductions? Of course not. But keep in mind that the statute of limitations for tax fraud is long, and includes interest and penalties. While criminal convictions are unlikely for some minor tax violations, it can and does happen to repeat and flagrant violators.
It is also unnecessary to incorporate strictly for the purpose of taking business deductions. Even if you are “running a business on the side” outside of the hours you spend employed by someone else, you may take tax deductions from your business expenses incurred doing this side work. You simply list your business income and expenses on Schedule C of your normal tax return. There is some evidence that taxpayers who use a partnership return (Form 1065) are audited at a much lower rate than those using a Schedule C. (Form 1065 is also used by LLC’s that elect to be taxed as partnerships, so if you fear a tax audit, forming an LLC may be a good option for you.)
Incorporating for the Right Reasons
If you are self-employed or are a small business owner, incorporating your business (forming an LLC in particular) is a good idea because it legally separates the entity that is your business, from the individual person that you are.
Many states permit what are called Profession Corporations (P.C.) or Professional Limited Liability Companies (PLLC’s). These are used by licensed professionals, such as doctors, lawyers, and accountants and they offer some liability protection from the malpractice of your “partners”, or members of your professional group. However, they do not typically shield you from the legal consequences of your own negligence or malpractice. To be protected from your own actions in a P.C. or PLLC, you would need to purchase insurance.
Steps to Forming an LLC..the How
Now we can discuss the nuts and bolts of “how to incorporate” your business! It is actually relatively simple to form and LLC. We have broken down the steps here for you.
First: Identify the state in which you will be incorporating, or “forming”, your LLC. Generally, you want to incorporate in the state that you live and work in, unless you have a significant reason to incorporate elsewhere. Don’t believe the hype about incorporating in Nevada, which some people thinks will allow them to avoid paying any state taxes. In the case of the state of California, for example (and many other states), California residents who own a Nevada corporation or LLC are taxed personally for their Nevada profits or salary. While there are legitmate reasons to form an LLC outside your state of residence, avoiding state income taxes is not one of them, particularly if your LLC is taxed as a pass-through entity.
Second: You need to file Articles of Organization for your state. In most states, this is a 1-or 2-page form. You can fill it out yourself, or you can hire an online incorporation company to do it for you.
Third: You may file for a Federal Employer Identification Number — also known as an EIN or FEIN. This is similar to a Social Security number, but is for businesses instead of individuals. You’ll need it to file tax returns and open bank accounts, as well as establish business credit. In some cases, a single member LLC without employees can use the Social Security number of the sole owner/member instead of an EIN.
How to Incorporate In Your State
Each state has its own rules for how to incorporate an LLC, as well as its own fee schedules, annual reports, etc.
If you use a service like Legalzoom to form your LLC, they will keep track of these things for you. But, if you choose to form your LLC yourself, then it’s your responsibility to keep accurate records.
This is why I have created state-specific pages for instruction that you can access below. Each state has its own rules about how to incorporate an LLC, different fee schedules, annual reports, etc.
State Specific How-To Form An LLC Pages:
How to incorporate a small business (non-state specific information).
How to incorporate in New York (coming soon).
How to incorporate in Georgia (coming soon).
How to incorporate in Virginia (coming soon).