I've talked to a couple lawyers about this and their advice, somewhat surprisingly, was that you don't need to incorporate until you're past the "project" stage. Specifically:
1.) You're handling money. As soon as money's involved your liability goes up significantly - plus, the corporation needs its own bank account.
2.) You have investors. They need an entity to be able to invest.
3.) You need the business to continue if one of the people involved backs out. If you're a few guys in a garage, your startup is probably screwed if any of you back out, and so having a formal shareholder agreement and property owned by the corporation doesn't really gain you anything. If you're an operating unincorporated business with something of value and your tech cofounder backs out, he holds the business hostage, because he owns the IP.
4.) You're doing anything that's risky and may piss people off, eg. spammy marketing campaigns, crashing peoples' conventions, abusing another company's API, scraping data where the ownership is unclear. You can get a lot of protection from lawsuits simply by not pissing people off; people who aren't mad at you and don't think you've wronged them don't sue you. But if you're doing something that's a grey area, you really really don't want your personal assets at risk.
The main downside of incorporating is that then you have to deal with all the administrative details of being a corporation. You have to pay yourself minimum wage, or else you're in violation of minimum wage laws. You're taxed on the income you receive as wages (even though it's just a transfer from yourself to yourself), so the IRS is taking 15% or so of your runway off the top. You have to file both corporate and individual taxes, which is a big distraction when you want to be working on your product. You need to have at least nominal board meetings (in the beginning, this can be just you and your cofounder sitting down at the table), where minutes are kept. It also costs a few hundred in fees, which is money you don't get back if the startup never finds any customers (as most don't).
Basically - you can and should be "just a person working on a project" when you're building. When you release it to the world and let people who you don't personally know use it, it's probably time to incorporate.
Just to clarify- if you are incorporating as an S-Corp or C-Corp you do pay taxes off the top, but if you file as an LLC you have pass-through taxation, meaning that you only pay tax on your income, the business doesn't have to pay taxes on top of that.
Further clarification: that depends on your election as an LLC. You can elect to be taxed as a corporation as an LLC, in which case the taxation will not be pass-through as a disregarded entity or partnership, and you'll need to file the normal 1120 corporate return.
Thanks. Just a point of clarification on (1). Is that just for taking IN money as opposed to just paying out for things like purchasing computers, software, freelance to design your website, etc?
Yes, but you probably also want to incorporate if you're paying out money. The business relationship a third-party supplier has is with the entity that pays them. If you buy something from a supplier on your personal credit card, they're unhappy with the transaction, and they sue, they sue you and not the corporation.
You're probably fine if you're buying commodity products like, say, web-hosting. You might get into trouble if you do it with negotiated purchases like contractors. YMMV; again, "not pissing people off" is a pretty good legal defense, and I certainly know folks that have hired artists or app developers before incorporation without anything bad happening.
1.) You're handling money. As soon as money's involved your liability goes up significantly - plus, the corporation needs its own bank account.
2.) You have investors. They need an entity to be able to invest.
3.) You need the business to continue if one of the people involved backs out. If you're a few guys in a garage, your startup is probably screwed if any of you back out, and so having a formal shareholder agreement and property owned by the corporation doesn't really gain you anything. If you're an operating unincorporated business with something of value and your tech cofounder backs out, he holds the business hostage, because he owns the IP.
4.) You're doing anything that's risky and may piss people off, eg. spammy marketing campaigns, crashing peoples' conventions, abusing another company's API, scraping data where the ownership is unclear. You can get a lot of protection from lawsuits simply by not pissing people off; people who aren't mad at you and don't think you've wronged them don't sue you. But if you're doing something that's a grey area, you really really don't want your personal assets at risk.
The main downside of incorporating is that then you have to deal with all the administrative details of being a corporation. You have to pay yourself minimum wage, or else you're in violation of minimum wage laws. You're taxed on the income you receive as wages (even though it's just a transfer from yourself to yourself), so the IRS is taking 15% or so of your runway off the top. You have to file both corporate and individual taxes, which is a big distraction when you want to be working on your product. You need to have at least nominal board meetings (in the beginning, this can be just you and your cofounder sitting down at the table), where minutes are kept. It also costs a few hundred in fees, which is money you don't get back if the startup never finds any customers (as most don't).
Basically - you can and should be "just a person working on a project" when you're building. When you release it to the world and let people who you don't personally know use it, it's probably time to incorporate.