If you are in the process of starting a new business, deciding on whether or not to incorporate that business can have long-term consequences when it comes to taxation and personal liability protection. This is why it is important to separate myth from fact about business incorporation; here are five common misconceptions:
- Incorporation allows businesses to avoid state income taxes. New Jersey has a 9% corporate income tax that must be paid by corporations with net income over $100,000. S corporations are generally exempt from this income tax, as are LLCs and sole proprietorships since profits and losses from these entities pass through to an owner’s personal tax returns. If your company is incorporated in New Jersey, but also does business in another state, you may also be responsible for paying state income taxes in that state.
- Incorporation always protects you from personal liability. The primary advantage of establishing your business as a corporation or limited liability company (LLC) is that your personal assets are protected from business liabilities. However, there are some situations where you could still be held personally liable — i.e., If the corporation or LLC has not been properly maintained, if you provide a personal guarantee on a business loan, if you sign a contract using your own name instead of the name of the Corporation or LLC, or if you engage in any criminal misconduct.
- Corporations can take advantage of more deductions. Any business — be it a sole proprietorship, Corporation or LLC — is eligible to take deductions on business expenses that are ordinary and necessary. Incorporation may help business owners save on self-employment and payroll taxes, but are not eligible for additional reductions just because they are corporations.
- Incorporation can be done at any time. It is not unusual for entrepreneurs to believe that they can delay making a decision on how they will operate their business until they are ready to go to market. However, incorporating a business in the early stages can provide important personal liability protection since liability issues can crop up before a product is even launched. If you start a business with the hope of selling it quickly, early incorporation can be a benefit since you must hold the stock for over a year in order to treat proceeds from the sale as long-term capital gains rather than ordinary income.
- Incorporation allows you to shelter income. Some entrepreneurs may think they can shelter income by stashing cash inside the corporation. However, the corporation must pay taxes on that income, and when profits are removed via paying dividends, the owner must pay taxes on his or her personal return. To avoid this “double taxation” issue, many small business owners elect to operate as an LLC or S corporation.
Johnson Legal PC founder Adrian Johnson, Esq., worked on Wall Street for many years, where he bought and sold over 100 companies. He has built his law firm with experience and technological savvy to ensure clients have 24/7 access for their business legal needs. Contact us to learn more about how a great corporate attorney can help your business thrive.
