The Reasons Not to Incorporate

Incorporating a business can seem like a good idea, but the process and requirements of incorporation can actually hinder an organization’s growth and success, especially for smaller start-up companies. Incorporating a business provides some benefits, but the corporation definitely pays the price for these benefits in fees and legal hurdles. The main reasons not to incorporate include a sizeable initial investment, tax disadvantages, increased complexity in bookkeeping and public disclosure mandates.

The most important benefit of incorporation is that is provides limited liability for its owners, something that sole proprietorships and partnerships do not do. Limited liability incorporations provide financial protection of the owner’s personal assets. This financial protection is more important to certain businesses than others; if your business does not a have a high likelihood of being involved in legal suits, the costs and disadvantages of incorporation will probably outweigh the benefits.

The first drawback of setting up a corporation is the amount of time and money required to do so. To receive a certificate of incorporation, you'll incur multiple filing fees—and possibly spend additional money on a lawyer if the legal process for your company's incorporation is complex or confusing. The filling fees and required documents vary by state, but a typical list of corporation requirements can look something like this: certificate of incorporation, annual corporation fees, appropriate accounting reports, tax returns and withholding tax returns. The process to obtain evidence of incorporation from the government can take close to a month, if not longer.

The second reason to avoid incorporation is double taxation. Legal business structures, such as sole proprietorships, partnerships and limited liability companies, are only taxed based on individual income; corporations are taxed based on organizational income plus individual income. According to the Internal Revenue Service, corporations can avoid double taxation only if they elect to become an S Corporation: “Shareholders of S Corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates.” Although this is definitely a benefit if the company is successful, if the company falls into debt, this pass-through taxation can put an extra financial burden on the owners of the corporation.

Another reason to avoid incorporation is the increased complexity of organizations operating under a corporate shield. Besides the financial and document requirements, corporations are forced to operate with a formal organizational structure of stockholders, a board of directors and officers; these members are required to conduct annual, timed meetings. The last disadvantage of corporations is the amount of information that must be made public. Corporations are publicly traded companies, therefore requiring more business information to be disclosed for the benefit of investors. Besides being required to make accounting records public, the organization must also identify all directors and officers publicly.

Deciding whether or not to incorporate is much more than just understanding the disadvantages of incorporation; the decision also requires knowledge about the advantages and disadvantages of other legal business formation options, such as sole proprietorships, partnerships and limited liability companies.