In this guest post, Jason Stark, business attorney, answers some of the most common incorporation questions (because as blogger or young professionals, we have a lot of questions, right?). Hope you all enjoy!
As a business attorney, some of the most common questions I receive involve incorporation. Starting a company can be overwhelming and many people delay their incorporation because of lingering confusion. I’ll provide answers to some of the most common questions so we can help you overcome your legal limbo.
When should I incorporate?
It’s never too early. Seriously. Incorporation is fairly quick and inexpensive when compared to other startup costs. Incorporation provides you with legitimacy in the eyes of both your customers and investors. A properly structured and operated corporation is the best way to protect your personal assets from liability. A corporation can also save you money because it provides tax flexibility beyond what a sole proprietorship offers. Finally, if you’ve got co-founders, incorporation allows you to accurately document the ownership.
I’m only a freelancer. Should I still incorporate?
The gig economy is the future. Many freelancers with no partners, employees, or corporate brands ask me whether it makes sense to incorporate. In many cases, incorporating or forming an LLC is still a wise decision for freelancers. Liability protection is one of the attractive features of starting a corporation or LLC. In practice, this protection means that a judgment from a lawsuit could only be enforced against your company, not you personally. In most cases, this protects your personal assets, like your personal bank account, from being subject to the lawsuit. Every freelancer has a different risk profile, but if there is any chance of liability stemming from your work, I’d recommend protecting yourself with a corporation or LLC.
How are corporations taxed? How does this compare to running my business as a sole proprietor?
I could write an entire post on this, but I’ll try to provide the abridged version. First, let’s discuss the differences. If you’re just running a business with no official entity, you are considered a sole proprietor. If you form a corporation, your profits will be taxed differently. In most cases, you’ll need to choose between forming an S Corporation or a C Corporation.
As a sole proprietor, your business income is directly included on your personal tax return. The entire amount (with some limitations) is subject to a special, not-so-fun kind of tax known as self employment tax.
If you form an S Corporation, you can pay yourself a reasonable salary and take the remainder of your profits as dividends. This has the potential to limit you tax liability, because only the salary portion is subject to self employment taxes.
Finally, a C Corporation — which is favored by investors — has the most complex tax structure. Profits are taxed twice: first at the corporate level and again as distributions. However, if you’re planning on retaining earnings (rather than paying everything out to the shareholders), this can result in a nice tax savings.
State laws and individual situations can change the calculus, so it’s worth speaking with an attorney or CPA before diving in. A good business formation attorney can walk you through various scenarios.
If my co-founders and I split up down the road, how do we divide assets?
You should hope for the best but plan for the worst. Sometimes, companies fail or founders end up in serious disagreements. When starting a company, you should make certain that your attorney puts together a well drafted set of bylaws. Good bylaws contain rules for dissolution or exiting shareholders.
How can I prevent outsiders from buying into my company?
Let’s say you and your friend Jane form a corporation for your startup. You each own 50% of the shares of the corporation (which in itself might be risky). You experience some early success and Jane decides that she would like to retire to Tahiti while she’s young. Her crazy Uncle Bob offers her $1,000,000 for her shares and she jumps at the opportunity. Now you’re in business with crazy Uncle Bob. Not good.
In order to prevent this, your company can adopt a “Right of First Refusal.” This requires selling shareholders to offer their shares to the company before they can sell it to a third party.
How much does it cost to form a company?
This varies a bit and you’ve got some options. You can check out my more comprehensive post on this subject here.
Now that you're incorporated, grab TCM's Guide to the Perfect Elevator Pitch!
Got more questions you’d like me to answer? Feel free to send me an email at firstname.lastname@example.org!
Jared Stark is a business attorney licensed in Florida and Washington, DC. He holds a law degree from Georgetown University and loves speaking with entrepreneurs about their ideas – from mobile apps to comic books. You can find him at StarkBusinessLaw.com.
Read the original article on Invibed. Copyright 2016. Invibed is an online community for successful millennials who are building wealth and creating their dream lives. Follow Invibed on Facebook, Twitter, and Instagram.