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Q: I recently started a home-based business selling various types of products over the internet and I am wondering whether to incorporate. I am concerned about personal liability, and have heard that by incorporating I will eliminate all personal risk. However, I also want to ensure that I maintain control of my business. Would you recommend incorporating? And, if so, what type of corporate entity should I choose? [name withheld]
A: Thank you for your question, and congratulations with the success of your home-based business.
Illinois likely would recognize your business in its current form as a sole proprietorship. A sole proprietorship, in essence, is an unincorporated business run by an individual. There are several advantages of structuring your business as a sole proprietorship, including the ability to maintain control, which is one of your major concerns. In a sole proprietorship, the owner of the business controls all business decisions. There are no reporting requirements with the state (although most counties require you to file a fictitious name certificate), no need for corporate meetings or votes, and no need to consult with other individuals to make business decisions. In short, a sole proprietor enjoys complete control over the decision-making process.
However, a sole proprietorship also has disadvantages. Because the business and owner are recognized as the same legal entity, a sole proprietor is liable for all company debts and obligations. Therefore, if you continue operating as a sole proprietor, you will be assuming liability for all debts and obligations of your company. The sole proprietor’s risk of personal liability is one of the main reasons why many business owners choose to incorporate.
A corporation, as opposed to a sole proprietorship, is a separate legal entity distinct from its shareholders. As a result, the shareholders of a corporation generally enjoy limited liability from the corporation’s debts and obligations. This means that if the corporation gets sued, the shareholders likely will not be exposed to personal liability. That being said, there are certain exceptions to the rule of limited liability. These exceptions usually involve cases of corporate fraud, gross negligence, and/or willful and wanton conduct. If one of these exceptions apply, the company’s “corporate veil” can be pierced, which could subject the shareholders to personal liability. Barring an exception, though, shareholders generally enjoy limited liability from company debt.
One specific type of corporation chosen by many small business owners is a Subchapter S corporation. With a Subchapter S corporation, shareholders receive the benefit of limited liability, while also receiving the benefit of flow-through taxation enjoyed by a sole proprietor. In a Subchapter S corporation, company profits and losses flow-through to the shareholder’s personal income tax. This allows a Subchapter S corporation to avoid the dreaded “double taxation” to which most corporate profits are subject.
Corporations also have disadvantages. In Illinois, corporations are subject to more government intervention and regulation. Corporations, including Subchapter S corporations, must file annual reports, conduct annual meeting, prepare minutes, and must conduct business in accordance with the provisions set forth in its Bylaws, or, in the absence of Bylaws, in accordance with the provisions of the Illinois Business Corporations Act.
From the limited facts in your question, it appears you may want consider incorporating your business and electing Subchapter S status. This will provide you with limited liability from your company’s debts and obligations, and afford you the benefit of being taxed as a sole proprietor. However, by electing to incorporate, you will be subject to more regulation, and must conduct business in accordance with the provisions set forth in the company Bylaws.
I hope this answer has provided some useful information to help you determine whether to incorporate your business. This answer was only intended as a brief overview of some of the advantages and disadvantages associated with incorporating, and was not intended to identify or list every advantage or disadvantage of electing corporate status. If you would like to speak about any of these issues in more detail, please feel free to contact an attorney at our office.
Thank you again for the question, and good luck with your business!
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