Client Question of the Week: When should I incorporate my business?

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Question: When should I incorporate my business?

Incorporating-your-business Answer: This week I had an appointment with the owner of a small trucking company who wanted to know if he should incorporate. He has been in business for about five years and has grown the company to about $700,000 in revenue, but was still having small losses due to high fuel costs and a slow economy.

As I told him, there are really only four reasons to incorporate:

  1. If you are in an industry that has a high legal exposure such as doctors, construction, or trucking (due to possible accidents by his drivers). But this may not be enough of a reason. A business owner’s first line of defense should be their liability insurance. Many startup business owners have very few personal assets, so they are in effect “judgment proof”.
  2. To save taxes. About 87 percent of small businesses who incorporate are formed as S Corporations. The ability to save social security taxes is the big reason. The idea can be illustrated by considering a small business that has a Schedule C (sole proprietor) income of $100,000. They would pay self employment (SE) tax of $15,300 (15.3 percent) on this business income. If they are an S Corporation and the owner pays themselves a salary of $60,000, then the remaining $40,000 would be not subject to the SE tax, for a savings of $6,120.
  3. If the business has more than one owner. For these businesses, I highly recommend that they start off incorporated and structured as a S Corp. A partnership has shared liability by the partners. This basically means that your partner can borrow money or sign agreements that you are also personally liable for, even if you don’t agree with them.
  4. To look bigger then you really are. The idea here was that having the word “President” on your card made you look more attractive to your prospects. In the world of the Internet and social media, this just doesn’t work anymore.

These reasons must be compared to the following extra costs related to incorporating. These include:

  • The cost of having a good accounting system. For a Schedule C, all I need to prepare the income tax return are income and expense items for the business. Once you incorporate, I will also need good numbers for your assets and liabilities. This means spending the time and money to have a real accounting system–something that I strongly believe every business owner should have anyways.
  • You have the cost of incorporating. If you do it yourself online, this will cost you around $500. If you hire an attorney to incorporate you, this will cost you between $1,000 and $1,500.
  • You will need to file a separate corporate return that will cost you at least $750 per year.
  • In Texas, you also may have to pay a franchise tax of 4.5 percent on your gross profit.

So what did my trucking company owner decide? Well, he decided I had given him a lot to think about, and he probably will wait until the company starts to make money before he incorporates.

Like any good CPA, I need to add a disclaimer: Unfortunately, it is impossible to offer comprehensive tax info over the Internet, no matter how well researched or written. And remember, I love my readers but having me bookmarked on your computer doesn’t make you a client: before relying on any information given on this site, contact a tax professional to discuss your particular situation.