Should I Incorporate My Small Business?
An important question for small business entrepreneurs to ask themselves is
, "is my business too small to incorporate?" It's true, corporations not only limit the financial liability of the businesses's owners, they save its owners payroll taxes through the S corporation accounting rules.However, corporations carry extra costs for your business, such as extra state taxes and accounting costs. The resulting tradeoff is that you receive the benefits of tax savings and liability protection at the cost of larger state taxes and accounting fees.
To make sure you get benefits in line with the costs you may incur, consider the following tips:
Tip #1 - Don't Rush to Incorporate a One-Person Business for Liability Protection
If you're the only worker in a service business or you're obligated to personally guarantee loans or contracts with vendors or customers, you're not getting much liability protection. In this situation, you certainly don't want to incorporate for the "liability protection" reason. Just to be clear, if you provide personal guarantees you negate the liability protection of the corporation or LLC. Additionally, while a corporation or LLC will protect you from liability exposure based on your ownership, if you're a worker in the business, you may (if you're personally negligent) create liability. Example: Incorporating a trucking business won't protect you from personal liability if you run somebody over while driving said truck.
Tip #2 - Wait to Incorporate Until You're Solidly Profitable
Until you're making significantly more than what would be reasonable salary for someone doing your job, the tax benefits from incorporation are minimal. In other words, if your job for your small business corporation is worth, say, $30,000 a year, there's no benefit to incorporating the business until your personal annual profits exceed $30,000. At lower levels of profitability you won't be saving any money with the corporationeven though you will pay all the extra accounting costs. At $40,000 a year, as an example, the $1,500 or so you save in taxes won't exceed state fees and your accountant's invoices.
Tip #3 - Exercise Caution if You're a Professional Service Business
Professional service corporations with three or fewer employees, starting in 2011, will find it much more difficult to benefit from S corporation status. In a nutshell, professional service corporations with three or fewer key employees will be disqualified from using S corporation status to save self-employment taxes. (You can learn more in the "What is a Disqualified S Corporation?" FAQ question.)
Tip #4 - Consider the Limited Liability Company Option
One final point: If you're a one-owner business, you do have an alternative to incorporation that, though it doesn't save you from paying the state its fees, often will minimize your accounting costs; you can form a limited liability company and let the LLC's income and deductions get reported on your personal return. An LLC with one owner is, by default, treated as a sole proprietorship under tax law if the LLC operates an active trade or business. In this case, the LLC owner enjoys the simplicity of a sole proprietor's accounting and tax return preparation while enjoying good liability protection.
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