I have a lot of new freelancers in my community ask me whether or not they should incorporate their business.
So I wrote this article to break it down as easily as I know how.
In the United States, there are 3 main business types:
- Sole proprietorship
There are pros and cons to each one. Choosing whether or not to incorporate is totally up to you.
I am going to break down the benefits of each type of business in this article.
What is a Sole Proprietorship?
Most businesses in the United States begin as a sole proprietorship by default unless they formally incorporate.
The IRS defines a sole proprietor as someone who is the only owner of an unincorporated business.
With this type of business structure, you basically just start doing business as an individual.
You don’t need to register with the state or submit annual reports to form a sole proprietorship.
One of the disadvantages of being a sole proprietor is that your personal assets and business assets are at risk because the owner has unlimited liability for all debts, claims, and lawsuits against the business.
What is an LLC?
An LLC or a limited liability company, is a separate business entity whose owners are members.
LLC’s can be a partnership between two or more people. An LLC can also be owned by a single member.
By forming an LLC you are able to protect your personal assets and keep them separate from your business.
And this is one of the primary reasons why people who want to start a business incorporate into an LLC.
Typically with an LLC, if your business is sued, the plaintiffs aren’t able to go after your personal assets.
Another benefit of having an LLC is in regard to taxes.
The profits from the business are only taxed once.
These profits are considered “passed through” income to members personal income taxes which helps them to save money on taxes.
An LLC is also one of the easiest business entities to form as there is less paperwork needed compared to starting a corporation.
One thing to take note of: If you are a single member LLC, in order to get these tax benefits, you will need to elect how you would like to be taxed.
To save money on taxes, its best to elect to be taxed as an S-Corporation.
In order to get the tax benefits of an S-Corporation with your LLC, you need to file IRS form 2553.
You would still enjoy the benefits of being an LLC, but you will be considered a taxable entity by the IRS which could possibly reduce the amount taxes you have to pay on business profits.
What is an S-Corp?
Its a type of corporation used by small businesses.
According to LegalZoom.com “….all of the income or losses of the corporation for the year are passed through to the shareholders".
Those shareholders would report this income on their individual tax returns.
Shareholders can be employees and earn a salary. Typically if you start an S-Corp, you would be a shareholder.
Shareholder dividends are typically taxed at a rate much lower than personal income taxes are.
This is why many business owners chose this form of incorporation, to save money on taxes.
An S-corporation also protects you from personal liability as your personal assets are separate from the corporations assets.
One thing to note is that when you initially file for a corporation, it is automatically considered a C-Corporation which is a regular corporation.
You would need to file a separate form with the IRS to have your entity classified as an S-Corporation.
A C-Corporation is usually used by bigger companies.
If you don’t elect to be an S-Corporation, you may have to pay more taxes, especially if you are the sole shareholder and employee.
Which One is Better?
This is really just a personal choice and in my experience they all have benefits.
I have used both LLC and S-Corps for my businesses in the past.
I do however, prefer the simplicity of having an LLC because there is less paperwork to maintain each year.
Benefits of Incorporating
In addition to tax savings, having an LLC or an S-Corp let’s your business look more professional and can signal to customers that you are a credible business.
Here’s a summary of the benefits of both types of entities:
- Let’s you protect your personal assets
- You can save money on taxes
- Makes your business look more credible
How to Incorporate Your Business
There are two main ways that I have personally incorporated a business.
The super easy way, if you don’t like to fill out paperwork, is to use an incorporation service that does it for you.
You can pay between $200 - $500 to have a service incorporate for you.
The other way is to do it yourself.
If you choose to do it yourself, just visit the Secretary of State website for your specific state. They typically have a page for business incorporations.
Many states let you fill your incorporation papers online.
Here’s a list of Secretary of State website in the US: http://www.coordinatedlegal.com/SecretaryOfState.html
Choosing to incorporate your business can help you save money on taxes, protect your personal assets in the case of a lawsuit against your business and also helps you maintain a professional image.
Setting up the incorporation is also relatively easy and you can do it online.