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Learn2 Choose a Business Entity (continued)
Step 3: Understand the disadvantages of incorporation

Before you pay the costs to incorporate your business, it's important to understand some of the disadvantages (which could actually make other business structures, such as partnerships and sole proprietorships, more attractive):

Double taxation. Technically, corporations must pay taxes on profits. Then when after-tax profits are distributed as dividends to the owners, they (the stockholders) must declare this money as regular income and pay taxes again. Hence the phrase "double taxation." Double taxation isn't usually an issue for smaller, private corporations, who generally pay little or no corporate income taxes. Why? Because profits go directly into increased salaries or bonuses, thus avoiding corporate income taxes. However, double taxation is a concern for large, publicly held corporations who distribute profits to hundreds or thousands of shareholders.

Paperwork. Corporations are subject to strict rules about record keeping. If these rules are ignored, investors may lose their shield against personal liability. As a result, a corporation must expend more effort (and money) making sure it stays within the law. The fact that each state has its own set of regulations complicates matters, which means you should consult an attorney and a tax accountant.

Potential for decreased flexibility. Each corporation must have a board of directors. The board, which is usually elected by stockholders, has ultimate authority over the direction of the company, approving all major decisions. This may add a layer of bureaucracy to the management process that could make your company less able to respond quickly to a changing business environment.

Added costs. It costs money to incorporate your business. You'll also have to pay for added record keeping, and you may have to consult attorneys when you want to take any new or unusual action, just to make sure everything's legal.

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Step 1: Understand your options
Step 2: Understand the advantages of incorporation
Step 3: Understand the disadvantages of incorporation
Step 4: Consider the S corporation
Step 5: Understand LLCs
Step 6: Understand sole proprietorships
Step 7: Understand partnerships