Confusing information abounds regarding timing for company formation. Here are some facts to help you sort it out.
• If you are the owner of a business that is already up and running, the primary benefit to incorporating immediately, rather than waiting until January, is protection of personal assets. “Any minute you wait before incorporating or forming an LLC is another minute you are exposed,” says Glen Ross, a New York CPA.
• An active company that incorporates before year-end must prepare two tax returns: one as the proprietorship/partnership and one as the new corporate entity. However, costs to prepare the additional returns may be dwarfed by the potential savings on “self-employment tax.” Glenn Ross, CPA, explains it. “Self-employed business owners must pay 15.3% of their earnings to cover Medicare and Social Security obligations. Contrast this with the business owner who chooses to incorporate or form an LLC before year-end. He no longer pays self-employment tax on any profit that remains in the corporation or LLC. If the business owner incorporates during November or December rather than waiting until the following year, he stands to save on self-employment tax for that portion of the corporate profit that is not distributed as salary.”
• It may make sense for the aspiring business owner to wait until January to incorporate or form an LLC if the business is not yet operating. Since there is no business activity, the risk of waiting is reduced.
• A word of caution for those who plan to wait until January to file: January is a busy month for state offices across the country. States often develop backlogs and long waits for corporation and LLC formations at the start of the year. Good news: an incorporation service company can help you avoid the rush by placing your order in advance and submitting your company formation for you immediately upon start of the year.
In summary, operating businesses may prefer to incorporate before year-end to minimize personal asset exposure and to maximize self-employment tax savings. Businesses that are not yet active may prefer to incorporate in January to avoid the costs associated with submitting a prior year tax return for their inactive company.