Why and When Should I Incorporate My Business?
It’s common for entrepreneurs to start a business as a sole proprietorship. But as your business grows, you’ll start to hear the word “incorporate” more and more.
But what exactly does it mean to incorporate? What are the implications for your business? Do you need to incorporate once your business grows to a certain size? We have the answers:
What does it mean to incorporate a business?
Incorporating a business means setting it up as a separate legal entity. This provides you with asset protection in case your business ever closes or is sued.
You can incorporate your business as a limited liability company (LLC), limited liability partnership (LLP), S corporation, or C corporation.
All of these business entity options remove your liability, but they come with different restrictions and benefits.
The advantages of incorporation
There are lots of upsides that come with incorporating your business. These are just a few:
Reduce liability and protect personal assets
Incorporating your business separates your personal finances and business finances. So if your business fails, your creditors can only take your business assets to pay your debts.
It also reduces your liability for actions associated with your business. For example, if an employee is injured on the job or damages a client’s property, you as the small business owner won’t be personally liable.
READ MORE: What business insurance do I need?
Adding “Inc.” or “LLC” to your business name makes your operations look more established. The extra title will help you stand out from that unincorporated business down the street.
Open up new customer relationships
Some customers will only work with incorporated businesses. By taking that extra step and incorporating, you can reach a wider range of customers and bring in new business.
Preserve your brand
Incorporating your business involves registering your business name with your state government.
Because no other business will be able to use this name, you’ll be better able to protect your service business brand.
Build a business credit score
As a sole proprietor, your business depends on your personal credit score to get loans or credit cards. Incorporating allows you to build up a credit score for your business that’s separate from your own.
It also means business debt doesn’t count against you when you’re applying for a mortgage, line of credit, or other type of loan.
Save money on your taxes
Incorporating separates personal income from business income, so you can claim more small business tax deductions and might pay less on your income tax returns.
Your tax savings will look different depending on whether your business is a corporation or just an LLC, which is taxed as an individual. Check with your tax advisor for more information.
Banks and other lenders are more likely to offer a loan to an incorporated business rather than a sole proprietor. You can also sell shares of the business as part of an investment deal.
Starting your service business with a partner or plan to add one in the future? Incorporating makes it clear which owners have which financial and operational rights in the business.
It also helps if your business has any kind of physical or intellectual property. That way the business owns that property, not any one individual.
The disadvantages of incorporation
Incorporating comes with many benefits, but there are a few important downsides to consider, too. You can expect to:
Spend more money incorporating
You’ll pay an up-front fee for incorporating, followed by annual or twice-annual fees. This is on top of your normal business licensing fees and other costs.
You also need to involve a tax specialist and work with a law firm when you decide to incorporate, not just an accountant. Their professional fees will add up fast.
Follow compliance requirements
Every corporation needs corporate officers and a board of directors to oversee operations. You’ll also need to create bylaws, send out annual reports, and keep detailed records of all meetings.
There are even more responsibilities if you decide to sell shares in your business. You’ll be responsible to shareholders for every business decision you make—and they won’t always like what you decide.
Go through a closing process
Can’t or don’t want to do business anymore? As a sole proprietor, it’s easy—just stop accepting new work.
But as a limited liability company, LLP, S corporation, or C corporation, there’s a mountain of paperwork that comes with closing up shop when you’re incorporated.
When should I incorporate my business?
You should plan to incorporate your business before you actually need to, but not when you’re just starting out. There’s a sweet spot where it’s ideal to file your articles of incorporation:
When you start making good money
Wait to incorporate until you’re financially stable—think $60,000–80,000 a year in revenue. The incorporation process is complicated, and the financial benefits aren’t worth the effort until you’re earning enough to sustain your business.
READ MORE: Do I need a business bank account?
Before signing contracts
If you sign a contract as a sole proprietor, you’re responsible for fulfilling that contract as an individual. But signing as a corporation means your business is on the hook, not you.
That’s why it’s a good idea to incorporate before you sign a contract with a customer, supplier, subcontractor, or other business or organization.
Before hiring employees or bringing on partners
When you gain a partner or hire your first employee, you’re responsible for their actions on behalf of the company. Avoid that personal liability by incorporating before adding to your team.
Pro Tip: Consider incorporating at the start of a new year. It helps with taxes because you won’t have to file for only a small portion of the previous year.
Do I need to incorporate my business?
You don’t strictly need to incorporate your business—it’s just an option that’s available to you. But there’s a good chance it’ll be a smart option for your business at some point.
It all depends on your business and its risks, goals, and plans for the future. For example, incorporating might be a good fit for your small business if:
- You make more than $60,000 per year in taxable revenue
- There are certain tax benefit opportunities available
- You manufacture and sell your own products
- There’s a risk of injury at your office or on the job
- You have partners or employees and don’t want to be liable for their actions
- You might look for investors or sell your business in the future
Every business is different. As yours grows, consider all your options and speak with your lawyer and your tax advisor to see if incorporating is the right move.