The first thing that every home business should understand is that incorporating is not something you need to be afraid of. Incorporation is widely misunderstood as exclusive of average small businesses, when it is actually far more routine and advantageous for small businesses than most of them realize.
So, set aside your fears for a moment and take the paradigm leap into the transition between solo entrepreneurship and incorporation. These factors will help you along in the journey you’re taking from a fresh, new small business, into a mature and solid corporation.
Why Is It Good to Incorporate Your Home Business?
It’s a good idea to incorporate your home business for the same reasons that it’s a good idea for any other business. There is a reason that it’s a standard practice, even for very small businesses, and that’s simply because when you incorporate, you gain a great deal of advantages and protections that you would miss out on if you don’t.
We’ll explain those benefits further, but the first and fundamental reason you should incorporate is to separate yourself, as an individual, from the business, itself. Before your business becomes a corporation, it is by default, a sole proprietorship. Once you are a corporation, however, the business stands on its own, similar to a separate person.
It is, of course, entirely your choice whether you want to incorporate or not, but keep in mind that, as a sole proprietorship, you, yourself, are personally impacted by profit losses and similar consequences, as well as liable for legal issues or lawsuits. The corporation protects you from this because it is, for all intents and purposes, a separate entity in the eyes of the law.
Another important reason to incorporate is that it’s a great way to instill trust and confidence in investors, as well as clients and customers. When you are an incorporated company, investors aren’t as worried that you’re going to shut down without warning, and clients see the business as more trustworthy.
Furthermore, a big misconception about not incorporating is that the IRS is going to come after you. As long as you claim all of your revenue as income and pay the appropriate taxes, they will pretty much leave you alone. So, you don’t have to be as paranoid about not incorporating if that’s your decision for the business; however, once you start generating a good deal of revenue, you’ll be leaving a lot of money on the table if you don’t incorporate because it affords you a lot of tax advantages.
Incorporate as Soon as You are Comfortable Doing So
You definitely have to be prepared for the transition, but there’s honestly not much of a downside to incorporating. It’s pretty much always going to be good for your company, unless your business is closing soon, which you’re not planning on doing–right?
Becoming a corporation shows that you’re a serious company; it provides legal protection for the owner or owners; it attracts more qualified employees; and it also attracts larger investors. Remember that corporation designations were created specifically to give businesses a more concise and useful structure. They weren’t created for any insidious purpose.
These corporate statuses obviously make it possible for the government to tax businesses, but in doing so, they also incentivize incorporation to encourage owners to do it, which is why there are different types of corporation designations, so that you can choose the one that suits you best. As soon as you understand exactly what type of corporation fits your company best, and it is financially stable, it’s probably time to incorporate.
Get a Solid Footing Before You Incorporate
Although you can definitely incorporate as soon as you open the business, it may not be the best time. The truth is that you are the one who has done the research, you know how good your footing is than anyone else does, and you decide whether incorporating right away is a good idea for you; so, I would not presume to advise your business otherwise.
Just as an aside, it’s good to know that when you’re starting out, it’s a very challenging time and probably not the most opportune time to add more to your plate–unless you’re sure. This is especially true if you’re bootstrapping and working a full time job while you’re trying to get your new business off the ground.
That’s not to say that it’s not difficult when you instead have investors that you need to keep happy; it can just be even more draining when you are working another full time job to supply your business’ capital. During that crucial time after you open, your company may be barely making ends meet to keep your doors open, and those first few months and the first year are extremely stressful and unpredictable.
As it concerns incorporating, you most importantly want to make sure that your business model works; otherwise, you will have wasted a lot of work and costs of incorporation on an idea for a business that failed. The process of incorporating is time-consuming and has some cost attached, as well.
Know What You’re Getting Into
The benefits of incorporating come with added expenses, filing costs, processing, and the headaches of bookkeeping. There are most certainly great benefits to incorporating your business, but it’s not free and doesn’t happen instantaneously.
A lot can go wrong, and you could even unintentionally trigger an audit from the IRS by simply filling out or filing a form incorrectly. So, it’s clearly important to do everything right the first time. You cannot rely only on yourself to ensure the accuracy and thorough processing of the information and documentation of incorporation for your company (unless you are a professional in this field, yourself).
Plan on budgeting roughly $500-1000 per year for a good CPA. It’s also highly recommended that you pay a third party service to handle your bookkeeping. Those services range from $100-350 per month for small businesses. Just like your attorney and your mechanic, you definitely don’t want to skimp on those services because you always get what you pay for.
If you think of incorporation as a sort of black-and-white, in-or-out concept, then you would be wrong. There are multiple types of corporations because there are all kinds of businesses who operate at different levels and have different structures and needs. Here are the main types of corporations you can choose from and a general description of each:
Sole Proprietorship (not incorporated)
This is the business type which you are legally designated by default when you do not incorporate. In this structure, there is no distinction between the business and you, personally, as the owner. There is no protection from, “debts and obligations of the business,” (SBA) because the company is not designated as a separate entity. You are the business, and the business is you.
Partnerships are actually divided into two types: Limited Partnership (LP), and Limited Liability Partnership (LLP). This type of business structure is, of course, ideal for businesses with multiple owners, and which of the two types you choose depends on how you need to split the responsibility, among other things, of each owner. LPs basically, “have only one general partner with unlimited liability, and all other partners have limited liability.” (SBA) The difference with LLPs is that they, “give limited liability to every owner.” (SBA)
Limited Liability Company (LLC)
An LLC is one of the most popular business structures for a reason. Firstly, taxes are cheaper with an LLC than with a full corporation, while retaining many of the benefits of a corporation and a partnership, as well. You can pass profits and losses, “through to your personal income without facing corporate taxes.” (SBA) You can have multiple members in an LLC, but if someone joins or leaves, then many states will, “require the LLC to be dissolved and reformed with new membership.” (SBA)
Corporation (C Corp)
A corporation, also called a “C Corp”, is the classic structure and usually the most favorable to businesses. A corporation legally separates the business entirely from the owner(s) and is the best vehicle to protect you from any liability. The advantages of a corporation are essentially the reason a business should make the choice to incorporate. If you want to go this route, bear in mind that it is the most costly and tedious of the business structures. Profits are taxed, and can then be taxed, “again when dividends are paid to shareholders, on their personal tax returns.” (SBA)
S Corporation (S Corp)
An S Corp is truly underrated. An S Corp is what would happen if a C Corp and an LLC had a baby, and then that baby grew up to be conditional friends with the IRS. It is not taxed twice, as with a C Corp, and it is recognized by the federal government as a C Corp. If your company qualifies to be an S Corp, then you should jump on it because it basically gives you all the benefits of a corporation, with lower cost and liability.
B Corporation (B Corp)
Some states allow a business to have a “B Corp” legal status, which is designed to facilitate for-profit companies that operate with the same basic purpose and function of non-for-profit company. B Corp businesses have to regularly demonstrate that they contribute in some significant way to the public good.
There are also a few other less common types of business structures available which you may be interested in, such as a Close Corporation or a Collective. You can learn more about those by going to the Small Business Administration’s website, linked at the end of this article.
To sum up, incorporating your business is just about always a good idea, and when you decide to file for one of the available business structures mostly depends on the financial strength of your business, as well as the established success of your business model. It’s definitely a good idea to talk to other businesses who have incorporated to get more advice about the process and what to expect, and you can also find a great deal of information on the SBA website to get started.
What’s Next? Check out all of the articles in our series, Starting Your Home-Based Business:
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1. “Choose a Business Structure,” U.S. Small Business Administration, https://www.sba.gov/business-guide/launch-your-business/choose-business-structure