What is the difference between incorporated & unincorporated businesses?

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When starting a business there are many decisions that must be made. For instance, a person must decide what sort of business he wants to start and how many hours per week he wants to devote to the business. He must decide how much start-up money is needed and whether he wants to run the business from an office location or from home. And very importantly, he must decide what form or structure the business will take. For example, in starting the business the owner could choose to be unincorporated (and have a sole proprietorship) or could instead incorporate (form a corporation). In making these decisions, it is important to consider the differences between incorporated and unincorporated businesses.

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Cost of Formation

Having a sole proprietorship is generally less expensive than having a corporation because you don't have to formally register a sole proprietorship. On the other hand, in forming a corporation there is cost involved because there is formal paperwork that must be filled out and submitted to the state. This paperwork will require you to answer questions about what you want to name the corporation, the purposes of the corporation, the location of the corporation, the number of shares that the corporation will have, and who the directors will be. The filing fee for the paperwork for the corporation varies from state to state, and there could be additional cost if you choose to submit the paperwork through a website such as Legalzoom.com or if you choose to consult a lawyer who files the paperwork on your behalf or gives you legal advice about the corporation.

Tax Preparation

Being a sole proprietor is easier at tax time because you only have to file an individual tax return which includes your income and business losses or profits. In addition, you have to pay self-employment tax. On the other hand, if you have a corporation you have to file taxes for the corporation separately because your corporate income is separate from your individual income. Also, some people who already retain a professional tax preparer to prepare their individual tax return will also choose to have her prepare their corporation tax return, obviously at an additional cost.

Liability Issues

If you are a sole proprietor, you are individually liable for all debts and are liable if your business gets sued. In other words, if your business is sued, and if the plaintiff sues and wins, the money comes out of your own personal income and assets. By contrast, if you have a corporation and your business gets sued, there is protection of your personal income and assets because the business is treated as a separate legal entity such that, in most cases, if the plaintiff wins a lawsuit, he can only recover the money and assets from the corporation.

Taxation

Sole proprietors and corporations are taxed differently under the U.S. tax code. Sole proprietors are taxed once. There is no double taxation because your income from the business and your own personal income are taxed as one. Your business income is considered to be part of your personal income in a sole proprietorship. By contrast, owners of corporations will pay taxes on their own personal income and will also pay taxes on the corporation's profits.

Establishing Credit

In the United States, corporations have their own credit records. For example, as owner of a corporation your personal credit scores are viewed apart from the corporation's credit scores. The corporation is completely separate from the individual business owner in the sense that the corporation has its own credit rating and credit history that it builds as corporate credit is applied for. By contrast, a sole proprietorship's credit is one and the same with the credit of the individual business owner, and as such the individual business owner cannot build a separate credit history if she has a sole proprietorship.

Ease of Raising Capital

Businesses that are sole proprietorships generally have more problems raising money to fund the growth of the business than do corporations. For example, in a sole proprietorship shares of the business cannot be sold to others who might be in a position to help contribute needed money. If the owner can borrow sufficient money from the bank to fund the growth of the business, that is helpful but if the owner needs more money than he can borrow, then not having shares to sell to potential investors can be a problem. Corporations on the other hand have an advantage in the sense that corporations have shares that can be sold to investors to raise capital to fund expansion of the business.

Level of Formality Required

Sole proprietorships do not require the kind of formalities that corporations are required by law to include in their formation. For example, corporate boards of directors are required to have regular meetings. Also, corporate boards have an established structure which consists of directors, officers and shareholders. On the other hand, for sole proprietorships there are no such requirements for board meetings involving officers or shareholders.

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