I’ve involved myself in a serious joint partnership as well as a limited company arrangement; I’ve flirted with offshore this and offshore that…and my experience tells me that corporate anything can be a complete pain in the butt.

Setting up a corporation – whether state, interstate or offshore – is not something that should automatically feature on your pre-launch task list before becoming location independent & taking off round the world.

I know I’m beginning to sound like a scratched CD but I am forced yet again to reiterate my standard mantra: “It depends on your unique financial set of circumstances and what you are trying to achieve”. With that caveat now dispensed, the aim of this post is to give you some useful general guidelines to help you make a decision one way or the other.

At that point, I strongly suggest you talk with a professional who can walk you through the types of companies which may be appropriate for you…

How Companies Are Taxed

A company is usually viewed by authorities as a completely separate taxable entity with a different set of returns to your personal ones. A company is taxed by the jurisdiction in which it is incorporated even though you might have your own tax home elsewhere.

Advantages of Incorporating

The most important advantage of incorporation, whatever the type, is that creating such as entity gives its stockholders limited liability. What this means is that should the company run into financial difficulty, you have protection against creditors seizing your personal assets.

However, it’s important to note that should you choose to incorporate a single director operation (which is commonly what many location independent professionals do), carefully check the tax rules of the country where the company is established. You & your personal assets might not be as protected as you have presumed.

Other advantages include:

• Unlimited life – the corporation, not you. When you shuffle off this mortal coil or if you want to sell your interest, the company will continue to exist and do business.
• Insurance and retirement plans are easier to establish although conversely you might find you need additional life cover.
• Ownership of a company is easily sold or transferred through sale or transfer of shares.
• Capital can be raised through the sale of shares.
• A company may be allowed a far greater range of “expenses” than somebody who is merely registered as self-employed.

Disadvantages of Incorporating

Top of the list of disadvantages has to be double taxation.

The profits of a company are taxed first as income to the corporation, then secondly as individual income to the shareholder. On the plus side, all reasonable expenses such as salaries and other operating costs are deductions against corporate income which can have the effect of minimising double taxation. At best, it could improve your cash flow so what we’re really talking about here is a potential tax deferral as opposed to tax saving.

However, yax deferral isn’t necessarily a given. US sole proprietors, joint venture partners and S corporation shareholders may still be liable to Estimated Tax if they are expected to owe $1,000 or more when filing individual returns. Corporations, as separate tax entities in their own right, have to file for Estimated Tax if it is expected the company will owe $500 or more when the return is filed. Remember that those Estimated Taxes must be deposited every quarter so goodbye tax deferral.

Other disadvantages include:

• Complexity and expense of formation
• Legal costs if applicable
• Burden & cost of additional paperwork

When To Consider Incorporation

Many entrepreneurs automatically list “incorporating” as an item on their To Do list. Given some of the points above, it shouldn’t be a given. That said, there are a number of circumstances in which it’s worth considering. These include:

• You own property or other assets with a sizeable net worth
• If you are embarking on a joint venture with one or more people
• Your estimated turnover in the first year is greater than $100,000 pa
• You intend to employ staff from the outset
• You are an avid fan of the “Five Flags Theory”

When It’s Not Worth Incorporating

If you don’t meet the criteria above and the ones below are applicable to your personal circumstances then I’d seriously consider whether setting up a corporation is worth the time, hassle and cost given the limited benefits it will bring:

• You don’t own property or other assets
• You’re running your own show and do not envisage one/more joint venture(s)
• You have little idea as to your potential turnover, or it runs close to the tax threshold of your tax home country or (for the US) you do not envisage earning over the FEIE i.e., $91,400 for 2010 (2009 tax year) and will be travelling extensively outside the country
• You do not intend to employ staff within the first 6 months of opening for business

In my professional opinion, the best route to follow is to start off as a sole entrepreneur and “upgrade” when turnover and staff numbers dictate.

Editor’s Note: Concurring with Marion’s advice, having gone down the route of limited company (UK) and incorporating offshore in Panama (on advice from a qualified UK accountant), I can say that incorporation for us so far has proven to be a big fat costly waste of time providing little or no benefits. If you don’t understand some of the terminology above and you’re from the US and serious about expanding your knowledge on how best to maximise your tax & finances, a good place to start is the Location Independent Guide to Tax & Finances, authored by Marion.