What Is the Difference Between Incorporated and Unincorporated Businesses?

By Ari Mushell, J.D.

What Is the Difference Between Incorporated and Unincorporated Businesses?

By Ari Mushell, J.D.

You have a business idea and have researched your target market. After careful consideration, you've decided to set your idea in motion. At this point, you need to choose how to structure your business.

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The term "incorporating" refers to a formal process that creates an entity that is distinct from its owner. You incorporate by following your state's legal procedures, filing various forms and paying a fee with your Secretary of State or equivalent office. Once you complete the process, the newly created entity is distinct from its owner. It accounts for its own profits and losses and files specific tax documents.

Unincorporated businesses, such as sole proprietorships and general partnerships, are extensions of their owners. They don't require formal paperwork, and they don't pay corporate taxes.

Rules and Formalities

An incorporated entity must follow various rules and formalities. For instance, corporations must draft articles of incorporation, hold regular meetings, and produce minutes of those meetings. Incorporated entities must also register with the Secretary of State every year.

If you do not incorporate, you are not subject to any of these rules. There are no formalities and no annual registration.

Limited Liability

Incorporating your business provides limited liability. As mentioned, a result of incorporation is that the business entity and the individual are legally distinct. It follows that if a creditor holds a liability against the business, then the creditor cannot pursue the owner individually because the owner is distinct from the business. This benefit is perhaps the most essential aspect of incorporating because it shields the owner's assets from the entity's liability.

If you do not incorporate, there is no liability protection shielding your personal assets. You and your business are not distinct entities, so the business's liabilities are your liabilities—and vice versa.

Tax Benefits

Not incorporating can have tax benefits. Unincorporated entities only pay taxes once against profits the business earns. By contrast, a C corporation is subject to double taxation: entities organized as C corporations pay taxes on what the business earns, and then employees who receive payment pay taxes again against what the business pays them. In other words, profits of a C corporation are taxed on both corporate and personal levels.

Note that S corporations and LLCs avoid this double taxation issue by having pass-through taxation. This means that the profits earned by the business are not taxed at the corporate level and instead pass through to the employees or members, who then pay taxes at a personal level. Those seeking to incorporate and avoid double taxation often opt for an S corporation or an LLC.

Raising Capital

All businesses need capital. Some business models find raising capital easier than others. C corporations and S corporations can raise capital by selling shares to investors. C corporations can sell shares on the open market, while S corporations can sell shares on restricted markets.

Unincorporated entities and LLCs cannot sell shares in their respective businesses, so they must look to investors and lenders to raise capital.

It is exciting to launch a business. When launching, you must decide whether you want to incorporate. Incorporated and unincorporated entities have different benefits and disadvantages depending on the circumstances of the business and its owners. Consider which factors are most important to you when starting your company.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.