Protect Your Credit through Incorporation

By on March 5, 2014

There are 3 ways to own a business: a sole proprietorship, a partnership, and a corporation. Though starting up a business will require a look at your credit history, you want to protect your credit and personal finances once the business gets started. Incorporation is a great financial safety net for protecting your business.

Before we look at incorporating your business, let’s look at the other two types of ownership. In a sole proprietorship, you own everything, you pay all the costs, and every cent you collect is yours. The kid next door that mows lawns in the summer is a sole proprietorship. In a partnership, two or more people share the risk and rewards of their business.

If the kid mowing your lawn runs over a rock that the mower sends through a window, the kid is legally liable for the damage. Even worse, that rock could hit a small child and cause a serious injury.

5 Reasons Why You Should Incorporate

Separate Liability

Under US and most international laws, a corporation is considered a person. This means that a corporation is the stopping point for liability in both directions. What this means for you the small business owner is a protection of your personal credit if something happens beyond the business’s ability to repay damage. Let’s look at two examples.

  1. You own a store with its own parking lot. During the winter, a customer slips and falls on ice, causing a moderate injury. The person would sue the business entity for hospital bills and such, and would not be able to sue you the owner and take your car or house.
  2. While driving your personal car, you’re involved in a car accident that is deemed your fault. If the other person sues you, the business assets are protected, and you can continue to make money through your company.

Taxation

Under current tax laws, corporations have a lower tax rate than individual people. As a small business owner, you are able to retain more assets to the business to help keep it functioning effectively. Also, companies keeping detailed records can use losses from operating or expanding a business to offset future profits, reducing your tax liability while you grow.

There are two basic ways that a small business corporation can be taxed: as a C Corporation or as an S Corporation. A C Corporation is taxed just like you would expect. The business provides income and expense reports and pays taxes on the profits it makes doing business.

An S Corporation passes its profits and debts on to the shareholders. This type of taxation is commonly used for single owner/employee corporations, though can be seen in some other businesses. Though it can be more complicated, it can reduce the tax burden on the individual. Filing your taxes either way is best done by a licensed accountant unless you already have experience with tax laws for corporations.

Just don’t forget that you have to pay yourself from the business accounts and pay personal taxes on that income. Just taking money from the business without properly disbursing it is embezzling, even if you are the only employee. Unexplainable financial transactions will also negatively affect you if you ever apply for a business loan.

Business Credit Rating

When you incorporate, you will have to file for an Employer Identification Number (EIN) from the IRS. Your EIN is used just like your social security number for your business. You will use it for filing taxes, paying any employees that you have (including you the owner), and for opening any bank accounts that your company needs.

Just like you have a credit rating based on your credit history, your business will have its own rating based on its EIN. This is the rating that will be used to apply for business loans to expand or a business line of credit to operate more efficiently. Just like your personal credit rating, it is affected by amount of debt used compared to amount allowed, repayment of debts, and business history.

As a small business owner, you want that separate rating to protect your personal and business financial ratings. If your spouse loses their job and you have trouble paying bills on time for a short while, your business can still take out loans to grow so you can make more money to offset the lost income. If your business hits a rough patch of low sales, your personal history will not be affected if you need to purchase a new car.

Selling Stock to Raise Money

Raising money for a business can be done in two ways: adding debt or selling equity. Adding debt means taking out a loan from a bank or credit union. You are given money to do as you wish, and you have to pay it back with interest.

Selling equity is the fancy way of saying selling stock in your company. When you sell stock, you are selling partial ownership of your company to someone else. That person now gets a vote on how things in the company are run and can receive full access to the financial reports to review the business. The nice thing about selling stock is that you do not have to repay any money. The business can later choose to repurchase the stock to reduce the number of owners, but otherwise the business gets money without needing to repay a debt.

Selling stock is strictly regulated by the Securities and Exchange Commission, and you must be careful to follow all their guidelines. Before making any offerings, be sure to speak with a financial advisor to protect you from unknowingly violating a law.

Keeping the Business Alive (While You Retire)

Corporations are durable. Since the corporation is considered its own entity, you are building your own retirement payout. Corporate ownership is controlled by ownership of stock. That stock can be sold at a determined amount to another person who wishes to buy your business. The business that you started will continue to operate as something that you can be proud of creating, and you are able to make money towards your own future from selling it. After selling your business, you can either retire or roll that money into a whole new business, the choice is yours.

Ask a Professional if Corporation Works For Your Business

Setting up a corporation may help you to separate your personal and business finances in a way which protects your credit and tax liability.  Speak with a trusted business consultant, legal counsel or financial advisor to determine which business ownership model will work best for your individual situation.

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About Charles Wazig

FSN Business Columnist - Charles Wazig has been a business consultant for the past 10 years and has aided small and medium sized enterprises start and grow in almost every industry. Understanding markets and financial forecasting can be a daunting task, and Charles strives to make it easier for the common person to be fully prepared for creating and running their business. You can find Charles on !

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