When to Incorporate a Startup

If you’ve been operating your business as a Sole Proprietorship, you may be wondering when’s the right time to incorporate your startup as a bona fide business entity. There are various reasons to consider incorporation and its important to know your timing can matter!

Five Signs It’s Time to Incorporate

Naturally, every company’s situation is different, so various factors play a role in determining the ideal time to register a business entity. Circumstances when forming an LLC or Corporation may be advantageous for a startup include the following items.

1. Conducting Business Activities With High Liability Risks

Some businesses are riskier than others (e.g., construction vs. tutoring). Incorporating offers business owners peace of mind by protecting their personal assets because Limited Liability Companies and C Corporations are considered separate legal entities from their owners. That is not the case when operating as a Sole Proprietorship or Partnership, where the owners and the business have no legal separation and can be sued for the debts of the business. Conversely, if someone sues an LLC or Corporation, generally, the members’ or shareholders’ bank accounts, homes, retirement savings, and other personal assets cannot be taken as restitution or to settle debts.

2. Excessive Income Tax

If the passthrough tax treatment of a Sole Proprietorship or Partnership has become financially prohibitive, forming an LLC or Corporation may help minimize the burden. Unlike Sole Proprietorships and Partnerships, which are considered the same tax-paying entity as their owners, LLCs and C Corporations have flexibility in how they’re taxed. LLCs that meet the IRS’s eligibility requirements may elect to be treated as either an S Corporation or C Corporation for tax purposes, and eligible C Corporations may elect to be treated as an S Corporation. Those special tax elections can potentially save money for the business owner and the company. Again, this depends on multiple factors and should be discussed with a tax professional.

3. Desire to Continue the Business Perpetually

If business owners want the business to continue even if its owners retire, die, withdraw, or are removed, incorporation will make that a possibility. Corporations may continue to operate even if members or shareholders leave, pass away, or decide to sell the company. Most state laws also grant LLCs perpetual existence, allowing the owners (members to change without requiring the dissolution of the entity. Conversely, a Sole Proprietorship ceases to exist when the owner dies or decides to close the company. Likewise, a Partnership does not automatically have perpetual existence. Unless the company has an agreement in place that states that the Partnership may continue after a partner leaves, retires, dies, or is removed, usually the Partnership must be dissolved and a new one formed if the other partners wish to continue operating a business together.

4. Bringing on Employees

Hiring employees to help run and grow the business adds complexity and some increased liability risks. Switching to an LLC or Corporation adds an all-important degree of liability protection for business owners as they grow their companies and expand their workforce.

5. Seeking Financing

By forming an LLC or Corporation, a company may stand a better chance of obtaining loans and other financing. A business that’s formally registered with the state and displays “LLC” or “Inc.” at the end of its name may more easily earn the confidence of customers, vendors, lenders, and investors.

If any of the above scenarios resemble what your business is experiencing, it may be worthwhile exploring incorporation. Consider consulting your attorney and an accountant or tax advisor for guidance on which business structure will fit your goals and needs best.

Consider a Delayed Filing

Ultimately, when you decide to incorporate your startup is up to you. However, I’d be remiss not to mention that, as we near the end of this year, the old adage, “There’s no time like the present,” holds truth.

If you’re in one of the states that allow delayed filings, you can file your incorporation paperwork now and request a delayed effective date of January 1, 2025. Doing so can make life easier for you in several ways.

Here’s why a delayed filing might be the ideal choice:

• With switching business structure at the start of the tax year, you will only have one set of tax returns to file for the 2025 tax year. If you’d change your business structure mid-year, you’d need to file one set of returns for your Sole Proprietorship or Partnership for the period of time you operated as such and then another set of returns for your legal business entity to cover the time from when it was effective until the end of the 2025 tax year.
• Also, filing in late 2024 for a January 1, 2025, effective date avoids the requirement to pay the state’s 2024 franchise tax (where applicable) and other 2024 compliance requirements your LLC or Corporation would need to fulfill if it were made effective this year.
• Moreover, Secretary of State offices are usually extremely busy in January, so filing now for a January 1st effective date will help you avoid the backlog.

Things to Do Before and After Incorporating

State registration paperwork asks for information about the LLC’s or Corporation’s registered agent. A business owner must designate a registered agent before filing Articles of Organization (LLC) or Articles of Incorporation (Corporation) with the state.

After registering your startup as an LLC or Corporation, you can move forward with other tasks, such as:

• Obtaining an EIN for your business entity
• Opening a business bank account and credit accounts in your LLC’s or Corporation’s legal name
• Applying for business licenses and permits for your LLC or Corporation
• Registering your entity for state payroll taxes if you have or plan to hire employees

Resources to Guide You in Starting an LLC or Corporation

I’ve written many articles and our website offers helpful guides about incorporation. I invite you to explore them as you consider taking your startup to the next level.

• Should You Incorporate at Year End or Wait Until 2025
• Tax Benefits of Incorporating
• What Is a C Corporation?
• Do I Need to Register an LLC and Obtain a Business License?
• Sole Proprietorship vs. LLC
• LLC vs. Partnership
• LLC vs. C Corporation

You can also head on over to our Learning Center to browse through our resources and articles by topical area.