As with any missive on the subject of tax liabilities and the IRS, there are no cut and dried answers regarding whether or not it’s better to incorporate a small business, or leave it as a sole proprietorship.
There are several variables to consider (including the overall health of your business) when considering the type of business structure that will work the best for you and your situation. Following are some general guidelines, along with some pros and cons of choosing whether or not to incorporate.
One thing you must consider is the fact that if you DO incorporate, you will have two sets of income tax returns to complete. This means that you can be taxed twice; your corporation will pay income taxes, and you, as an individual will pay taxes on your salary and dividends you receive from the corporation.
It’s a good idea to confer with an accountant over these issues; it’s quite possible that your corporation would pay higher taxes than you would as an individual with a sole proprietorship, making the same amount of money.
Another consideration is whether or not your business is your only means of support. If you choose to incorporate, you need to make sure that at least SOME of the profits can remain in the business to use for expansion and reinvestment right back into the company. This isn’t possible if every penny you make goes to supporting you and your family.
Then there are the costs of incorporating. The initial fees, as well as the cost of retaining your corporate status can add up (an LLC, however, isn’t as costly as a C or S corp.).
There are other pros and cons to consider when making the “should I” or “should I not incorporate” decision:
*Limited Liability. A corporation stands as its own entity, separate and apart from you, the founder. This means that if your business gets into legal or financing trouble, your personal assets are protected. If you have sole proprietorship, you are the business and the business is you, so none of your assets are protected.
However, the limited liability question isn’t cut and dried either. For example, if you go to the bank for financing, the bank will likely have you “co-sign” the loan papers. This means that you are guaranteeing the ability of the corporation to repay the loan by putting your personal assets up as collateral. If the corporation tanks, the bank will necessarily come after you personally; this certainly implies something quite different than “limited” liability.
*Credibility. Typically, having an incorporated business gives a person more credibility, as far as customer perception goes. Whether or not this is fair or justified is a mute point; the fact is that SOME people out there will see the letters “inc.” after the name of the business as a sign of “success.”
*Capital Expansion. It’s somewhat easier to raise funds through the sale of stock or securities, if you decide to incorporate.
The bottom line is that whether or not you should incorporate is something you need to look at carefully; hopefully, in the presence of your accountant.