You don't have to incorporate to run a business, and sometimes, you shouldn't. Incorporating offers legal protection that most business structures don't offer, but it's much more cumbersome to run than a sole proprietorship or a partnership. If you go unincorporated, you can choose to incorporate later if your assessment of incorporated vs. unincorporated changes.
An unincorporated business is simpler and cheaper to run than a corporation, but incorporating provides legal protection against your personal assets being seized for business debts. Forming a limited liability company is simpler than incorporating and provides the same sort of asset protection.
Choosing your business structure requires more than just choosing between incorporated or unincorporated because there's more than one option in each category.
- The C corporation is the default incorporated setting. It can have unlimited numbers of shareholders, which makes selling stock an effective way to raise money. Your corporation pays tax on its earnings, while shareholders pay tax on their dividends.
- The S corporation can have 100 shareholders at most. Many small businesses organize as one-owner S corporations to gain corporate liability protection. The company pays no tax, as all income passes through to become the owners' personal income. Recent tax-law changes let you deduct 20% of that income on your 1040, which is also an option with unincorporated businesses.
- The sole proprietorship is the simplest business structure. In many cases, there's no paperwork or fees to file. Unlike a corporation, there's no legal separation between you and your company and no protection for your assets.
- Partnerships are the simplest structure for a multi-owner business. A written partnership agreement explaining how the power and decision making are going to work is a good thing to have, though not mandatory.
- A limited liability company is a hybrid. It's simpler to set up than a corporation and provides similar protection for your assets. It can be taxed like a corporation or like a partnership.
If you know anyone in business, you can probably find incorporated and unincorporated business examples among their companies. Talking to them may give you an idea of the pros and cons.
Liability is the big difference between incorporated and unincorporated companies. If you own a sole proprietorship or a partnership and you run out of money, creditors can legally seize your assets for unpaid debts. In the list of unincorporated business advantages and disadvantages, this is one of the big minuses.
Incorporating your company creates a legal boundary between your business assets and your personal assets. If your company can't pay its debts, your house, car and bank account are off limits to creditors or someone who sues you. An LLC, however, offers some of the same benefits without incorporating.
The protection from debt isn't unlimited. If you don't completely separate business assets and personal assets — for example, with separate bank accounts — a judge could rule that the corporation or LLC is just illusory. That voids your asset protection.
Financing is another difference between incorporated and unincorporated businesses. The ability to sell stock makes it easier for a corporation, particularly a C corporation, to raise money than an unincorporated business. While an LLC can protect your assets, it can't sell shares.
Setting up a corporation, however, costs a great deal more in both money and time. Creating a corporation requires a ton of paperwork; after you're up and running, there's yet more paperwork plus regular board and stockholder meetings.
Rather than look for hard and fast rules, decide the incorporated vs. unincorporated question based on your specific situation. If your business runs very little debt and you're not at high risk of being sued, incorporating may not be worth the effort. If your personal assets are large and your business has a high risk of being sued, liability protection may look a lot better.