If you’re a sole proprietor, incorporating your business could help fuel your growth even faster. However, deciding whether to incorporate could completely change the course of your business, so it’s best to do your research and figure out what’s best for your company. Here’s what you may want to consider before making the leap.
What are my incorporation choices?
When you’re a sole proprietor, you and your business are a single entity. Incorporating separates the two, making your business a distinct entity.
There are three main business types you can choose:
S-Corporation: This type of business was specifically designed for small businesses, as you usually won’t need to pay corporate taxes — just taxes on dividend earnings.
Limited Liability Company (LLC): This option allows you and other members (owners) to collect profits through the company without paying corporate taxes (in many states).
C-Corporation: This is more for bigger businesses or businesses that are growing fast, as it allows you to issue stock and set up a board of directors … but you have to meet more formal requirements and could be taxed both at the corporate level and personal income tax level.
What are the advantages of incorporating?
There are many advantages of sole proprietorship, including simpler taxes and more flexibility and control. That said, many businesses end up incorporating for a variety of reasons:
It helps protect your personal assets.
One of the biggest disadvantages of sole proprietorship is that there isn’t much liability protection. Incorporating legally separates you from your business, so if your company is sued or goes bankrupt, your personal assets are less likely to be at risk.
It could make it easier to get financing.
Banks are more likely to fund incorporated businesses over sole proprietorships. That said, if you’re willing to go an alternate route, you could still get the funding you need for your sole proprietorship with a personal loan, or a small business loan from a marketplace lending company such as Funding Circle.
It could make your company look more legitimate.
Fair or not, consumers and institutions often see incorporated businesses as more legitimate than sole proprietorships. Perhaps even more significantly, it could change the way you view and make decisions about your business.
Steven Hill of Simple Maui Wedding explains that “incorporating really makes you sit back and realize you aren’t just toying around anymore. You start thinking about how you can make your business better, not just get by. I believe it makes you think of your long-term strategy and not be so short sighted.”
It could save you money.
While taxes may become more complicated to file after you incorporate, it could be worth the hassle — incorporated businesses can often deduct losses, fringe benefits such as health insurance, and more. In fact, TurboTax explains that “even the smallest of businesses may benefit by incorporating.”
What are the disadvantages of incorporating?
Of course, incorporating isn’t always worth the benefits. Most of the cons boil down to one thing: convenience. Life as a sole proprietor is simple; incorporating makes almost everything a little (ok, sometimes a lot) more complicated.
For example, initiating and maintaining an LLC can involve a lot of paperwork (and fees), and you’ll usually have to be hypervigilant about keeping your personal and business expenses separate. Forming (and keeping) an S-Corporation may be even harder, as there are a number of legal rules and obligations you’ll need to follow.
What are the financial implications of incorporating?
It’s almost impossible to say whether incorporating will ultimately save or cost you money. If you choose to become an LLC, for example, fees can get pretty pricey, but your insurance may be lower and you may get extra tax incentives. Every business’ situation is different, so it’s important to talk to a financial expert before making any decisions.
It’s also important to think about how you’ll pay yourself if you do decide to incorporate. Steven Hill of Simple Maui Wedding explains, “I wish I had known that you need to pay yourself a salary as an employee of the business — not just take owner draws. When you take owner draws, you are on the hook for the taxes at the end of the year, but usually forget about that until you receive a tax bill for tens of thousands of dollars or more. All of my small business friends have faced this and not all of them make it through. My business is extremely healthy now, but I had to go through those learning experiences too.”
What are the legal implications of incorporating?
At a very high level, incorporating separates your business assets from your personal assets, which helps give you more liability protection — if someone sues your business and wins, they often won’t be able to take your personal assets.
Tax laws are extremely complicated and there’s no one “you should definitely incorporate your business if X” situation, so we’d recommend doing your own research and talking to a professional before making a decision.
While there are many advantages of sole proprietorship, it’s not the only path toward growth and isn’t right for every business. However, if you think your business could be sued at some point or you have personal assets you want to protect, you may want to consider moving away from sole proprietorship.
This article was originally written on October 17, 2018 and updated on July 18, 2022.