Many small businesses start out as sole proprietorships, and there's not a lot of legal or financial separation between their owners' business and personal lives.
As these new companies grow, however, many entrepreneurs come to the point of considering a new business structure and may think about creating a company or incorporating it. But they may not be clear on what that “Inc." at the end of business names really means.
So what does "Inc." mean ? It signifies that the incorporated company is an entirely separate entity from its owner(s), and it also means that the business is being run in specific ways with regard to federal, state, and tax law.
If you're considering creating an incorporated business, read on to learn more about the meaning of "Inc."
Does 'Inc.' mean a corporation?
The short answer is yes: “Inc." in a company name signifies that a business is a legal entity called a corporation or an incorporated business. "Inc." is an abbreviation of "incorporated."
There are two types of "Inc." Incorporating typically involves choosing whether you want to incorporate your business as an S corporation (S corp) or a C corporation (C corp). The differences between these types of corporations revolve around what types of stock they can issue, how many shareholders they can have, and how their income or profits are taxed.
A key element of a corporation or "Inc." is that it is a distinct entity with a legal status apart from its owners and shareholders. An incorporated business is seen as its own "person" under the law. This separation limits the owners' personal liability and allows the business to live on after an owner's or shareholder's death.
"Whether you're a small or a big company, you want to be incorporated for a key reason of liability," says Robin Gerofsky Kaptzan, partner and Asia-Pacific Chair at Zahn Law Group, LLP. "If you don't have a corporation, you could become personally liable. By having a company, you're putting a shield up between your company and the world."
Advantages of incorporation
There are several advantages to incorporating, but whether these are enough to make the process worthwhile for your company depends on your business goals, income level, and other factors.
"When they decide they want to incorporate, I always ask clients, 'What's your end game? What's your exit strategy? Where do you want to be in five or 10 years?'" says Kaptzan. "All of these questions and many more should be considered at the very beginning of setting up a business."
One of the major reasons to incorporate is to gain liability protection for your personal assets. If your corporation gets in financial trouble, you won't be personally liable for the fallout, presuming you've been keeping your corporation in good standing legally.
It is not necessary to become an "Inc." to get this benefit, however. You can also become an "LLC," which stands for limited liability company. This status also gives you the same level of personal liability protection, typically with less administration involved.
"The reason why we incorporate or select an LLC is we want to have this liability protection," says Neil Johnson, a CPA with Harness Tax LLC. "For some people, they want to have that separate legal entity so they can bifurcate business versus personal."
Reduce your taxes
To reduce your taxes, incorporate and then apply to the IRS for S chapter status to file as S corporation, advises George Feehery, a mentor with SCORE, a partner organization for the Small Business Administration, and an adjunct professor at Western Governors University.
“You can pay yourself a salary," he says. "In that case, 50% of the Social Security tax is paid by the corporation, which you can then expense. You as an individual pay the other 50%." Additionally, you only pay self-employment tax on the amount of income that is designated as your official salary.
You'll only secure a meaningful tax advantage if you're pulling in enough revenue to make the logistical demands of incorporating worthwhile.
"I like to see the business having at least about $75,000 a year in profit simply because when you go to the S corp vs. the single-member LLC, there are higher compliance costs," Johnson says. "Plus, you have to set up payroll. We don't want the compliance costs to outweigh the tax benefits."
Fund your company through stock
Many companies struggle to find funding to grow. Securing loans and grants can be difficult, as they often demand a certain number of years in business, a comprehensive business plan, or other requirements. Another method of accessing capital is to sell stock to raise funds, which you can only do if you incorporate.
“When you incorporate, you can issue stock and sell that stock to friends and family as a way to fund your business," says Feehery.
An S corporation can issue only a single class of stock and is limited to 100 shareholders, while a C corporation can have more than one class of stock and unlimited shareholders.
Are all corporations 'Inc.'?
All corporations are "Inc.," but not all business entities are corporations. A popular alternative to incorporating is forming a limited liability company, which has an “LLC" after its business name instead of an "Inc."
What is the difference between Inc. and LLC?
Both corporations and limited liability companies are legal entities that create a separation between a business and its owners and/or shareholders. It can be confusing to parse the differences between a corporation and an LLC, especially because LLCs can elect with the IRS to be taxed as an S corporation or a C corporation.
“The magic tax fairy dust with an LLC is choosing how to be taxed," says Johnson. The main differences between an Inc. and an LLC involve the requirements for maintaining the business' legal status and rules about shareholders and stock.
Corporations must do a number of things to retain legal incorporated status, such as filing an annual report; holding annual meetings; and maintaining corporate minutes, corporate bylaws, and an operating agreement. LLCs typically only have to file an annual report. Every corporation must have a director and a registered agent who agrees to receive important legal and tax documents on behalf of the business.
The other major difference is that LLCs cannot issue stock and have shareholders, while corporations can. The rules for how many shareholders a corporation can have vary by whether the company is an S corp or a C corp, but in both cases they can raise money by selling shares. LLC owners must raise money in other ways.
Inc. vs. LLC: Which is better for a small business?
Corporations and limited liability companies are simply two different options for how a company wants to set itself up; as such, neither one is objectively better than the other. But one will likely be a better fit for your company.
Both corporations and LLCs are legally separate entities that limit business owners' personal liability. But they differ in how much work is required to maintain their legal status and whether they can issue stock. LLCs require less administrative upkeep, but they cannot issue stock.
One reason that small business owners choose LLCs is that failing to maintain your business' legal status through proper management can expose you to personal liability after all. For this reason, an LLC's ease of upkeep is a major point in its favor.
"There's a concept called piercing the corporate veil, allowing a person to challenge you and say, 'You didn't really act like a corporation, so we can come after you personally,'" says Kaptzan. A corporation must do a decent amount of documentation, counseling, and legwork to defend itself from such an accusation.
"You need to file an annual report to keep the corporation in good standing, and you're also required to maintain corporate minute books and have annual meetings," says Johnson. "We find a lot of small businesses don't necessarily do those things; they just file the annual report. You may be forming the corporation to have some sort of liability protection, but if you're not doing all these things, it makes it easy for an opposing attorney to pierce the corporate veil."
Johnson advises his clients that they can accomplish the same things as a corporation taxwise by becoming an LLC and electing to be taxed as a C corp or S corp but with less maintenance and risk.
How to choose your business entity type
The most common form of corporation is a C corp, which pays income taxes on the corporate level and issues dividends to its shareholders. C corporations can have an unlimited number of shareholders. S corporations, like LLCs and sole proprietorships, are "pass-through" tax entities, also called disregarded entities. This means the business income is reported on the business owners' personal income tax returns. An S corp, also called a close corporation, can only have 100 shareholders, all of whom must be United States citizens.
Figuring out which type of "Inc." to become (or whether to become an LLC instead) can be complex and is heavily informed by your goals for your business. It's a good idea to engage a CPA and/or lawyer to advise you on how to proceed with incorporating your business.
"There's a laundry list of pros and cons," says Kaptzan. "It comes back to 'what's your priority?' You want to leave yourself flexibility for future decisions."
An LLC can easily be transformed into a corporation (or can opt to pay taxes as a corporation), but it is difficult to turn an incorporated business into an LLC. This is why creating an LLC typically gives companies more flexibility.
Taxes are often the central factor in the decision about what type of business entity to create.
“It could be that you need to be more tax-advantageous because you're making a lot," says Kaptzan. “Just by changing a corporation's structure, you can potentially save a lot of money."
Also, shareholders of C corporations get money out of the business as dividends, a situation that creates double taxation. All the profits of an S corp, on the other hand, are taxed at the shareholder level, so there is no problem with double taxation. Such considerations should be part of your decision-making on how to incorporate.
How to create your legal entity
How you must go about getting the "Inc."—that is, incorporating—varies by state law and the specific type of corporation you want your business to become.
Many businesses choose to incorporate in their home state, but others pick states with laws that are favorable to corporations. Incorporating in Delaware is popular in this regard, with more than 60% of Fortune 500 companies choosing the state. Examples of companies that are incorporated in Delaware are Amazon, CVS, and Comcast.
The next step on the road to incorporation is to compile and file articles of incorporation with your chosen state's secretary of state. As part of this process, you'll need to identify a director and a registered agent for your corporation. Each state also has a filing fee that you must pay when filing the articles.
Feehery recommends getting professional help with the incorporation process, even if you have to invest some money to do so. “Is the cost of incorporating worthwhile? You can do it yourself, but it's a pain," he says.
And it's important to set your company up correctly, as it may be difficult to unwind mistakes later.
You can add 'Inc.' now
Once you have received notification that your business entity is registered with the state as a corporation, you are literally in business. At this point, you can formally add the denomination "Incorporated" or "Inc." to your newly formed corporation. Alternately, you can add the words "Corporation" or "Company," or abbreviations "Corp." or "Co."
No matter which business type you choose to create—whether you form a corporation or form an LLC—remember to properly maintain your legal status so, your company can thrive into the future.
Find out more about Starting a Business