Self-employment and small business ownership have many great rewards and benefits. Getting started as an entrepreneur is easy when you set up your sole proprietorship business. For many, the option of running their own business in this way makes the most sense. But perhaps, you have started to wonder if and when it is time to consider incorporating your small business.
Before we discuss the choice to incorporate your business be sure to read Understanding the Types of Businesses.
Is it Time to Incorporate Your Business?
Reasons to Remain a Sole Proprietorship
In most states, if you operate your small business using only your name, the only thing you would need to apply for is a sales tax license with the department of revenue. Getting started as a self-employed business owner is simple. While you may end up paying a slightly higher tax rate on profits earned, the process of owning and operating your small business is relatively easy.
An important note: if you want to operate your sole proprietor business using any other name, you will need to register with the Secretary of State office in your state. Register the name of your business with either a fictitious name or a doing business as filing. Fees for these registrations are usually either minimal or none at all.
Registering as an incorporated business will require legal filings, attorney fees, and possible fees with your state or federal government.
You also need to register for an Employer Tax ID number, an EIN, with the IRS. Each quarter you will have to file quarterly reports and annual tax documentation.
Many small business owners choose to remain as a Sole Proprieter because there is less hassle than incorporating.
Advantages of a sole proprietorship
- Simplicity – A sole proprietorship is the simplest type of business to start and operate. From the moment you begin selling goods or services, you are a sole proprietor.
- It is inexpensive – fees are low or no-cost.
- Easier tax filings – since you already file an individual or joint income tax return. You incorporate your small business earnings into your annual return. You may have to add additional schedules to your tax return but adding the needed schedules is relatively easy to attach. Here at Cowdery Tax, we will assist you with the process.
Disadvantages of a sole proprietorship
- Personal liability – You can be held personally responsible for the debts or legal obligations held by the business.
- Liability Insurance – One way to mitigate personal liability is to have small business liability insurance. The addition of the insurance fees is a disadvantage. However, having the security of insurance is an advantage. And even corporations utilize insurance for liability purposes.
Reasons You May Want to Incorporate Your Business
For sole proprietors, personal income and business profits get reported on personal tax returns. So your tax liability is dependant on your overall income.
With a corporation, the tax liability gets paid through the business’s tax filings. Since 2018, corporations have paid a flat tax of 21% on all their profits. Because individual income tax rates can range from 22% to 37%, depending on income levels, the tax rate for corporations is lower than that of individual tax rates for sole proprietor businesses. From the standpoint of tax savings, the sooner you incorporate, the sooner you begin saving money.
Ideally, the best time to incorporate a business is on January the 1st because your entire year will fall under the tax rate for the corporation. If you file at any other time, then you would need to file two returns. You would file one for the incorporated business. And you would file the non-incorporated portion of the year on your personal tax return.
One of the biggest reasons to choose to be incorporated is personal liability. The owner of a sole proprietorship bears the liability for whatever happens with the business. This means you are liable for any debts incurred by the business, including taxes.
Advantages of Incorporating Your Business
- Limited Liability Protection – The corporation bears all of the legal and financial liability of the business rather than the person(s).
- Tax Savings – The corporate tax rate is lower than the personal tax rate.
A disadvantage of Incorporating Your Business
- Governmental Requirements – there are more governmental requirements for corporations to report assets, profits, and losses related to the corporation.
- CPA Fees – most likely, you would need to hire a CPA to manage your federal tax filings. Cowdery Tax can recommend a CPA for your needs if you choose to incorporate your business.
Many successful small business entrepreneurs choose to remain a sole proprietorship because it is easier than incorporating. Before you decide if and when to incorporate your business, take some time to think about the requirements needed to report your business taxes.