When Should I Incorporate My Business?

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Canada-784392_1920This 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. You are in an industry that has a high legal exposure, such as medicine, construction, and trucking (due to possible accidents by drivers).  But this may not be enough of a reason.  A business owner’s first line of defense should be their liability insurance.  Also, many startup business owners have very few personal assets, so they are in effect “judgment proof”.
  2. To save taxes.  About 87% of small businesses who incorporate are formed as S-Corporations.  The ability to save on 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%) on this business income.  If they are an S-Corporation and the owner pays himself a salary of $60,000, then the remaining $40,000 would not be subject to the SE tax, for a savings of $6,120.
  3. The business has more than one owner.  For these businesses, I highly recommend starting 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 really just doesn’t work anymore.

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

  1. The cost of having a good accounting system.  For a Schedule C, all I need to prepare the income tax return are the 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 anyway.
  2. The actual 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 about $1,000 to $1,500.
  3. You will need to file a separate corporate return that will cost you at least $750 per year.
  4. In Texas, you also may have to pay a franchise tax return of 4.5% 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 that he would probably wait until the company started to make more money before he incorporated.

Like any good CPA, I need to add a disclaimer:  Unfortunately, it is impossible to offer comprehensive tax info in this magazine, no matter how well researched or written.  And remember, I love my readers, but subscribing to this magazine does not make you a client.  Before relying on any tax information given in this magazine, contact a tax professional to discuss your particular situation.