Self Employment: Should You Incorporate?
By Michele Blandino
Many people dream of setting up their own businesses. The reasons for going into business and the goals of the owners will be as different as the people establishing them. Some people dream of escaping from the rigid bureaucracy of the corporate world, others will set their business up to establish a secondary source of income while still others will have bigger dreams of turning their venture into an enterprise that will be handed down to future generations.
As you begin to establish your business, you will be confronted with many decisions ranging from identifying the sources of capital you will need to get the business off the ground to figuring out how much to pay yourself. One of the many - and perhaps most important - decisions you will need to make as you establish your business is whether to incorporate the business or “go it alone” as a sole proprietor.
The Case for Sole Proprietorship
The decision to remain a sole proprietor depends largely on the type of business you will operate. Because sole proprietors are in effect doing business as individuals, they put their assets including their home, car, and other personal assets at risk should creditors come calling. As a result, one of the first things you will need to do is make an honest assessment of the financial risk of your business and balance that with the amount of risk you are comfortable taking.
If the business you are establishing is a direct sales business – perhaps you are selling Tupperware® or a similar product – then, chances are your risks will be minimal making sole proprietorship quite appropriate. If, on the other hand, you are performing some type of service – maybe you are a painter or other type of home-improvement contractor – you should be aware of the possibility that a client may be dissatisfied with your work and will attempt to recover damages. As a sole proprietor, your own assets can be used to pay for these damages.
Another consideration in this decision is the amount of effort you are willing to make in completing your tax filing and other responsibilities. Comparatively speaking, the tax filing requirements for sole proprietorships are not as complicated as they are for corporations.
When it Makes Sense to Incorporate
As mentioned above, incorporating your business makes sense when there are financial risks associated with that business. Unfortunately, since everyone’s tolerance for risk is not the same. there isn’t a magic formula for determining how much risk is too much.
One of the biggest differences between a corporation and a sole proprietorship is the role of the owner. In a sole proprietorship, you, the business owner are considered to be the owner as well as an employee of the business. When you incorporate, you are no longer the owner – the corporation is – you are merely an employee of the corporation. As a result, your liability is limited to the extent of the assets of the corporation.
And, because you are an employee, you will receive a salary from the business, meaning you will not bear the entire tax liability of the corporation as you would had you chosen to remain a sole proprietor.
It probably comes as little surprise then that establishing a corporation is more complex than setting up a sole proprietorship. In fact, you will need an attorney to assist with the necessary filings.
The fees for setting up a corporation vary depending on the complexity of the filing and the attorney you choose – you should budget $250 - $500. There are a few corporate structures to choose from, however, subchapter S is the form most commonly used for home based operations.
The Required Disclaimer
The information presented here is intended only to give you an overview of the differences between the two different business structures. It is not intended to be a substitute for actual legal advice. Before deciding on the appropriate structure for your business, you should consult with your own legal counsel.
