If you've just started a business, one of your first questions may be should you incorporate your business or not?
The real question is: how official or not official are you looking for your business to be? That's not to say that a sole proprietorship isn't an official business. It absolutely is. But when you incorporate your business, you're going to create significant other advantages and disadvantages that you don't get by being a sole proprietorship. So what are we talking about?
A sole proprietorship is when you've opened up your business, you're operating your business, and you don't have any separate filings. You don't have a separate business tax number. You may not even have a separate business account, although you probably should. You'd be amazed how many of my clients come to me in just this situation. A lot of times they've created a side hustle, a business they're doing outside their normal work hours, and it's now starting to take off and they want to know what is the next step.
A sole proprietorship has three advantages and three disadvantages for you to consider:
- There's no paperwork, you can just operate your business get it set up.
- There's no annual filings with your state.
- There are no extra tax returns.
So if you've been doing your own taxes at home, you've been working on TurboTax you're all set to go. However, there are disadvantages:
- You don't have liability protection. If something goes wrong with your business, somebody is suing you individually, not the business.
- It's hard to get financing or business credit lines if you are a sole proprietorship versus being an incorporated business.
- You're unable to take care of certain tax advantages like an S Corp or a C Corp election if you are a sole proprietorship.
Incorporating Your Business
Now the other end of the spectrum has a lot of different options for you. You can be a corporation, you can be an LLC (Limited Liability Company), you can be a professional company, you can be a partnership. All of these are forms of "incorporated businesses" and these businesses have advantages. The advantages include:
- You usually have liability protection. So if somebody is going to sue your business, they're suing you, your personal assets are not on the line.
- It's also easy to get financing and business credit, you have a separate company, you have an entity with a tax ID number. It's easier to work with banks.
- Tax elections like S Corp and C Corp elections that can save you on taxes and can be benefits for how you receive income from your company.
Incorporating does also have disadvantages:
- There's more additional paperwork than a sole proprietorship (which has no paperwork).
- Annual filings ~ most states have an annual filing and/or an annual meeting requirement.
- Local taxes that are only a tax on businesses that wouldn't be on an individual.
- It's more complicated to file tax returns when you have an incorporated business versus a sole proprietorship. You'll have your personal tax returns you have to do and you're going to have your business tax returns you have to do.
When you start a business, you should think about both of these as options. Many people will start as a sole proprietorship, and that's perfectly fine. They operate for years and everything's going great, but maybe they take that next step now they're bringing on more employees. They have more complicated finances, and then it's time to incorporate their business.
Work with a professional, talk to your accountant about what kind of company you should set up, what kind of tax elections are available to you. Work with an attorney who helps to set up businesses. They'll get your operating agreements in place and they'll get your filings correct. If you have contracts that need to be done, like employment agreements, that attorney can help you be an invaluable resource for you as your business grows.
If you need to speak to an attorney about getting your company set up, we can set up a complimentary Legal Strategy Session to discuss what is the best option for you and your business. You can go the sole proprietorship route, you can go the incorporation route, whichever you choose, I suggest you speak to a professional who can help you make the right choice for you and your business.