Today’s Biz Ladies post comes from Karen Kobelski, general manager of BizFilings, an online incorporation provider. While we have previously covered the topic of incorporation, this post delves deeper into the details of incorporation, including the various types of incorporation you can choose from and the best location for your incorporation. Thanks, Karen, for such an informative post! — Stephanie

Read the full post after the jump . . .

Hi! I’m Karen Kobelski, and I’m going to share a bit of useful information about incorporation and other essential things to know as you start your small business. As general manager of BizFilings, an online incorporation provider, I’m proud to provide support to the millions of entrepreneurs in America following their dreams. We’ve incorporated hundreds of thousands of businesses, and it’s been such a joy to see the range of business ideas over the years. There are some really creative people (like you!) out there.

Why do I need to incorporate?

So, why is incorporation important? We get this question a lot. Many people operate their business as a sole proprietorship (which isn’t necessarily wrong). Being a sole proprietor may make sense for those starting out because it’s less expensive in the short term than incorporating. What being a sole proprietor doesn’t provide, however, is any liability protection between your personal assets and your business risks — and if things go wrong, this can be the most expensive scenario of all.

Imagine you’ve started a bakery, and someone sues your business (perhaps for something simple and seemingly innocuous — remember the famous McDonald’s lawsuit over the fact that hot coffee is, indeed, hot?). Even if you’re found not to be in the wrong, you’re still likely to incur up to thousands of dollars in legal fees. If you were incorporated, your home, car and personal assets would be covered under liability protection and couldn’t be seized to pay these legal fees, but if you were a sole proprietor, these assets may be fair game. It’s heartbreaking; you’ve spent years saving and building your personal assets, and without liability protection, they can be taken away to settle business debts.

Picking the “right” kind of incorporation

Another question we get asked a lot is what kind of incorporation is the “right” or “best” one. The simple answer is that there’s no single kind of incorporation that is “right” for everyone. Our most popular kinds of incorporations are LLCs (limited liability companies), C corporations and S corporations — these make up over 90 percent of our business formations. You can also choose to have a business entity, such as a nonprofit corporation, LLP (limited liability partnership) or PLLC (professional limited liability company), but these aren’t as common.

To decide which type of business formation is right for you, you’ll need to consider your particular ownership structure and future business plans (e.g., do you plan to go public or continue being privately held?), as well as analyze your tax considerations.

Knowing your audience (in terms of lenders) can also be important. If you’re interested in raising money through venture capitalists, these tend to prefer investing in C corporations. Also, if you eventually want to be publicly traded, be aware that you’ll have to be formed as a C corp at that time.

Different formations offer different kinds of tax savings. An owner of an S corp or C corp who is also an employee can minimize self-employment taxes by taking a more modest (yet appropriate) salary and taking more business earnings as income, which is not subject to self-employment taxes. With an LLC, there is no distinction between salary and income, so all of the owner’s income is subject to self-employment taxes. Both LLCs and S corps offer pass-through taxation, which means there is no income tax paid at a business level; instead, the profits and losses of your business are reported on your personal tax return, and any tax due on business income is paid at an individual level.

Because there are so many choices, we offer an Incorporation Wizard and business-type comparison table that explain the differences between business types and help entrepreneurs determine which formation is best for their business.

I’m ready to incorporate (and finally picked a type), but what state is best?

After choosing your business formation type, you’ll need to decide where you should incorporate your business. Where to incorporate is another common source of confusion. Often, people think that they should incorporate in Delaware or Nevada because they’ve heard it’s “less expensive.” And it’s true that these two states are popular for incorporation, but they have hidden traps.

For example, if you incorporate in Delaware or Nevada but operate your “brick-and-mortar” business in another state, you’ll also have to register your business in that state, and that means you’ll have to pay filing fees (and have ongoing compliance obligations) to your business’ home state as well as to the “cheaper” Delaware or Nevada. This can mean that incorporating in Delaware or Nevada actually requires you to pay twice the fees and do twice the work. It’s true that incorporating in Delaware or Nevada makes sense for some (we’ve written about the reasons for this at BizFilings.com), but most of the time, it doesn’t really save you money when you’re getting started.

I’ve heard about foreign qualification for my business, but what does that mean? I’m still selling in the US, right?

Once you establish a physical presence or hire an employee in a state other than the state where you incorporated, you need to qualify your business in that state. This is called “foreign qualification.” You must register (foreign qualify) your business with any state where you have “nexus,” which is defined as having employees, property and/or some other tangible presence in the state. “Foreign qualification” has nothing to do with leaving the country — it simply means that you’ve established “nexus” outside of the state in which you originally incorporated your business. It gives your “foreign” business a legal right to do business in a state other than where the company was formed. So if you form in Wisconsin, but you hire a salesperson in Minnesota, your domestic Wisconsin corporation/LLC should be foreign qualified in Minnesota.

Foreign qualifying your company is important because if you don’t, you can be fined, held liable for back taxes and lose access to that state’s court system in the case of a lawsuit. Often, these consequences can be much more expensive than the cost of foreign qualification.

Once you’ve picked a business formation and the state you want to incorporate in (or states, if you’re growing and expanding), you’re set to succeed with your small business! Of course, there are ongoing compliance issues, end-of-year reports and more, but that’s for another post!

I hope this overview has helped you decide what kind of business formation is right for you and answered some of the questions that we often get. Remember that the information provided here is general in nature and is not intended to replace the counsel of an attorney. If you’re interested in learning more about what I’ve explained or have other questions about incorporation or compliance for your small business, I’ll happily take your questions via the comments section below. Or you can use our Small Business Roundtable on the BizFilings’ Facebook page, where each Wednesday we take questions from entrepreneurs and have experts answer them via video.

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