When starting a small business, you will undoubtedly have to make a lot of decisions, one decision being: Should I register my small business as a corporation? So, let’s not overcomplicate it.
In this article, I will address:
- Corporations vs. LLC
- Pros to incorporating your business
- Cons to incorporating your business
- What qualities make states favorable to register a corporation In
- 8 states to register a corporation in
- States it may be disadvantageous to register a corporation in
- Other notable states based on a breakdown of their corporate income tax
- Incorporating in a state you do not live in
- Incorporating online businesses
- Key takeaways
Corporation vs. LLC
The first thing that you, as a small business owner, should know is that there is a difference between registering your business entity as a corporation and registering your business as a Limited Liability Company (LLC).
A corporation, also commonly called a c corporation, is an entity that is legally and completely separate from its owners. This means that the corporation will see its profits, be taxed for those profits, and is legally liable for how it conducts business. It is a business structure that protects an owner’s personal liability the most, but its maintenance can be both expensive and extensive. Corporations are subject to paying an income tax based on their profits and also require extensive record maintenance.
If a business is registered as an LLC, it becomes a pass-through entity (PTE). This means that the working capital gained by the company goes right to the owner and investors of the company as monetary income. As an owner of an LLC, you are only liable for the amount of money you invest in the company.
Pros to Incorporating Your Business
There are strong benefits to incorporating your small business. For one, it establishes your business’s credibility. This will make trust networks with prospective customers easier, according to the California Society of CPAs, as people associate the “Inc.” and “Corp.” titles to be signifiers of stability and longevity. It will also make getting loans and creating a business bank account much easier. As noted in the Small Business Chronicle, lenders, investors, and banks will often ask for proof of your business’s registration before granting a loan or a business bank account.
Having these vital resources will increase your opportunity to access and grow working capital.
There are also tax benefits to registering a small business as a corporation. If your small business is incorporated, its profits are taxed and though taxation of a corporation is a complicated process, it creates a lot of opportunities for tax reductions from expenses used for creating working capital like advertising, marketing, travel, and general operational expenses. Corporations can also omit the money being used for their employee’s salaries, benefits, and retirement plans from being taxed.
Lastly, registering your business protects you from personal liability. Out of all business structures, it has the most asset protection. If your small business is a corporation, it has the ability to assume liabilities and property and sue. This being said, the corporation’s handlings are separate from the owner’s, including any incurred debt. In effect, your personal assets can remain just that, entirely separate from the finances of the corporation, and safe in case of a financial deficit. Perhaps most importantly, your name is not tied to the corporation, which can help you retain anonymity if you so choose.
Cons to Incorporating Your Business
Despite the advantages of incorporating your business, there are also reasons why you may not want to.
For one, it can be expensive. Forbes put together a comprehensive list of all of these costs. Some of these fees and taxes include:
- Incorporation filing fee with the Secretary of State
Although price ranges by state, this is a fee paid when filing a Certificate or Articles of Incorporation.
Service providers can help you file all of the necessary forms to incorporate your small business.
The registered agent is the person who assumes and addresses legal and tax correspondence for the small business corporation (a necessity if you register your corporation in a state in which you do not reside).
This is an annual tax required by some states.
Only paid once, this is for those that are doing business using another name than the one filed with the Articles or Certificate of Incorporation to the Secretary of State. DBA is an abbreviation for “Doing Business As.”
- Annual filing fee with the Secretary of State
Some states require an annual filing with the Secretary of State. This may come with additional fees.
While the extra monetary expenses that come with incorporating a business seem to be the biggest disadvantage, the Small Business Chronicle also lists a few other potential disadvantages. For one, there is an extensive amount of record-keeping required of incorporated business owners. This includes detailed meeting minutes and bookkeeping, and both bank account and tax return records. Also, while some business owners may embrace the separation between themselves and their corporation, there may be a disadvantage to this lack of personal proprietorship. For one, business owners are no longer able to mix personal and business funds once the business becomes incorporated.
This lack of personal property is further complicated when owners of incorporated businesses sell stock in an effort to pay off business expenses. Shareholders can become partial owners of your business, and in effect, business owners will no longer have full agency when it comes to making company decisions. For example, shareholders can elect the board of directors, as stated by the Small Business Chronicle.
What Qualities Make States Favorable to Register a Corporation In?
While it is important to assess both pros and cons of incorporating your business, it is also important to assess how business incorporation differs by state. As noted by Corporate Direct, the two variables to consider is the rate of each state tax, as well as the level of protection you feel your business needs.
7 States to Register a Corporation In
Incorporating your small business is more beneficial in some states than in others, depending on how many fees are required and other corporate perks.
The state of Delaware has progressive corporate law and statutes and has a Court of Chancery to specifically rule on business-related disputes. It also has relatively low tax rates. A 2021 U.S. News article notably stated that Delaware ranks as the third-highest state in brick-and-mortar company headquarters. The Delaware Corporation serves as an optimal model for businesses interested in incorporating.
Much like Delaware, Nevada has progressive corporate law and statutes, as well as a specified court system to rule on business-related disputes. Nevada also does not have a personal income tax, nor a tax n corporate income, franchises, or corporate shares.
South Dakota’s annual fees and taxes are low in comparison to most states. For example, South Dakota also does not have a personal income tax, nor a corporate income tax. Its only pitfall is its high unemployment insurance tax.
Alaska does not have a personal income tax, and its other taxes are relatively low to moderate, across the board, like its unemployment insurance tax and its property tax.
Texas’s annual fees and taxes are low in comparison to most states.
Florida’s annual fees and taxes are low in comparison to most states as well. In fact, Florida’s 2021 corporate income tax was 4.458 percent, ranked amongst the lowest in the country. These low fees make for a stable, entrepreneurial state.
States it May Be Disadvantageous to Register a Corporation In
California is definitely not the most business-friendly. Corporate Direct calls its franchise fee “notorious.” Plus, it continually has one of the highest corporate income taxes, 8.84 percent, as shown in the Tax Foundation’s 2021 breakdown.
According to the Tax Foundation’s 2021 breakdown of tax rates and brackets, New Jersey has the highest corporate income tax, 11.5 percent.
Connecticut has a high personal income tax, and one of the highest property taxes.
New York has a lot of high taxes and fees, including a high personal income tax, property tax, and sales tax.
Other Notable States Based on Breakdown of Corporate Income Tax
The Tax Foundation’s 2021 breakdown of tax rates and brackets confirmed which states had the lowest corporate income tax in the year 2021. While these states did not make the above list of which states to register a corporation in, their noticeably low corporate income tax proves them to be favorable places to consider registering your corporation in, and perhaps doubly so if they are your home state.
Here are the cheapest states to incorporate in, based on corporate income tax (Note that this does not consider excess fees):
North Carolina’s corporate income tax in 2021 was 2.5 percent, ranking as the lowest income tax in the country. Missouri’s corporate income tax in 2021 was 4 percent; North Dakota’s income tax in 2021 was 4.31 percent; Colorado’s corporate income tax in 2021 was 4.55 percent; Arizona’s corporate income tax in 2021 was 4.9 percent, and Utah’s corporate income tax in 2021 was 4.95 percent.
Incorporating in a State You Do Not Live In
As per a recent article on score.org, most business owners will incorporate their business in the state in which they live. However, business owners do have the ability to incorporate in a different state.
You should always consider the fact that every state will collect some type of tax revenue on a business’s profits, and if you have any employees or a brick-and-mortar location in a state separate from the one you choose to incorporate in, you will have to pay taxes based on the profit made in that separate state.
Although some states are definitely more business-friendly than others, incorporating in a state that you do not live in will require you to hire a registered agent who has a physical location in that state. The registered agent will collect legal notices on your business’s behalf. However, this is further complicated if you also have a brick-and-mortar location in your home state, despite not being registered there. Although this is allowed, it will require both annual fees and reports in the state you are registered in, and the state that you are working in.
Incorporating Online Businesses
Without a brick-and-mortar location, you may have freer rein to choose where you would like to incorporate and can choose a business-friendly state like Delaware or Nevada. However, hiring employees negates this freedom, as it essentially tethers the online business to the state that the employees operate from.
A Few Things to Consider
Business owners should consider how certain states accommodate businesses, but also weigh these benefits for their particular business. For example, some states have specialized courts for business disputes, though the author asks small business owners to consider if they will ever need this. These benefits that arise in certain states can seem appealing, and can be helpful to some, but may not ever directly benefit you. And if that is the case, it is important to weigh the benefits that certain states offer with the fees that will ultimately incur.
Incorporating your business is all about strategy. As a business owner, you should always be looking to maximize profit. Although a state’s business-friendly policies may advertise a profitable corporate expenditure, as a business owner, you must look to your business’s best interests.
Furthermore, I want to remind readers that these findings only levy states that are business-friendly mainly based on their taxes and fees and some corporate structures. If your home state ranks as one of the worst states to incorporate in, consider that it still might be one of the best states to start a business in. For example, according to a 2021 article in the U.S. News, California (ranked one of the least business-friendly states based on its high taxes and fees) has a business survival rate that was amongst the highest because of the number of human assets and resources available to businesses. Massachusetts and New York ranked closely behind.
So, creating a successful business is about considering the bigger picture and assessing all variables.
And remember, if you are a small business owner, seeking to register a corporation and are considering selling stock: There are other ways to finance your business expenses, including applying for loans. Applying for working capital and term loans can be made easy with Biz2credit.