Should you incorporate your business? I get this question a lot, and recently I have been getting more of it after I wrote about the tax benefits of owning a business. So here are my thoughts on the subject matter.
Business incorporation is done for several reasons such as liability protection, tax planning, the ability to raise capital through investment (such an IPO or Initial Public Offering), and others. Should you incorporate your small mom and pop operation however?
If you are running a legitimate business, no matter how large or small, my answer will always be yes. That said, tax compliance governing authorities like the Internal Revenue Service (IRS) take a closer look at income tax returns showing “business” activity.
In the event you are audited (which is a random selection process and anyone can get audited), then you better make sure you can prove to Uncle Sam that you are running a legitimate business. Sufficient record keeping and segregation of funds (bank accounts) will suffice.
What Constitutes a Legitimate Business?
What is a legitimate “business”? Technically any activity carried with the intention of making a profit. That is a summary of what Webster’s dictionary says. Essentially, if you are engaged in activity or activities with the intention of making a profit, then you are technically in business.
Whether you incorporate your business is your decision. The IRS allows you to conduct business as a sole proprietor, meaning as an individual conducting his or her business activities. As a sole proprietor, there is no distinction between your business and self. You two are one in the same, at least from a legal and tax compliance perspective. Many DBAs (Doing Business As) are sole proprietorships.
As a sole proprietor, you file tax returns as an individual, reporting both your earnings from employment (if applicable) as well as your business activities. If you incorporate your business, you typically report profit or loss from your business activities on a separate form on your tax return, such as Schedule C.
Liability Protection When You Incorporate Your Business
For a relatively small operation, there is typically not much difference whether you opt to incorporate or run your business as a sole proprietor from a financial or tax planning perspective.
The biggest reason many choose to incorporate is for liability protection. Incorporating your business separates the businesses profits and assets from your personal assets. This is particularly important in the event you are sued.
Incorporation doesn’t necessarily mean that you need to register your company with the Securities and Exchange Commission (SEC) and hire expensive accountants and lawyers, although that would be the track if your business was to grow largely.
There are other, less intimidating and simpler routes such as forming a Small Corporation, also known as an S-corporation or a Limited Liability Company, or an LLC. As an S-Corp or an LLC, you benefit from the liability protection of a corporation, thereby protecting your personal assets, yet get to operate your business as an independent sole proprietor.
Who Should Incorporate?
Everyone should incorporate. I used to think liability protection is more relevant for riskier professions such as law, accounting or financial consulting. Lawsuits are prevalent in those professions, and therefore practitioners often incorporate their business to shield their personal assets from any claims in the unfortunate event that they are sued.
However, with the recent rise in lawsuits filed against website owners and bloggers, I encourage you to think about what you are doing carefully. Anything can happen in a trigger-happy society that we live in today, so why leave anything to chance?
Sure there are exceptions to the norm just like with anything else in life. If you are simply taking paid surveys or reading email to make money online, I highly doubt you could get sued for specifically those activities. Heck, who would even know you are doing them other than those you tell?
So while I sit here and preach that everyone should incorporate, you should really evaluate your situation and the activities you are conducting to determine whether incorporating your business is the right decision for you.
The Cost-Benefit of Incorporating Your Business
Incorporating your business is not free, and in many cases not cheap either. But thanks to business registration services like Socrates, which was created by professional attorneys, the cost is much more manageable today. In some states, the cost of incorporating is reasonable enough for people to incorporate just for the sake of bragging that they own their own company.
Many think they are “cool” when they own a company. How would you like to hit the bar and tell the beautiful stranger you meet that you own your own company when you are asked what you do? But then again, you could just as well lie. Who would know?
Take Michigan for example where it costs $25 to register an LLC. The process is so easy and you can do it all on your own online. It just doesn’t make sense not to. But in other states like California and Texas, incorporation costs start at $300 and only go up. So you should incorporate your business in Michigan! No really, something to think about if you live in such states.
What Should Bloggers and Website Owners Do?
The answer is a no brainer. Take some time and incorporate your business today. Why leave destiny to chance? Think about it. When you own your website or blog, you are putting yourself out there in the public eye. Anything you say can be harped on by anyone for any reason. You just never know.
When I look at my online business, I treat it as its own entity. It has a structure, a product, a service and it makes me money. There are expenses that go with maintaining my business such as domain costs, hosting, email newsletter programs, my home office, online training and education programs, and much more.
These are all legitimate and I can prove each and every one with detailed documentation. In fact I have been audited by the IRS twice already. The first time, they ended up sending me an additional check for $350 after they had already sent me my tax refund for the year, and the second time I passed the audit successfully with no financial give or take involved.
By now they know exactly what I do, how I do it and more importantly they are comfortable with it. So not only do I enjoy the tax advantages of owning my own business, but I also benefit from full liability protection, knowing that if my business was ever sued, no one could come after my personal assets like my house, cars, personal bank accounts, retirement savings, etc.
I highly recommend you take some time and ponder whether you should incorporate your business, especially if you are running a side business in addition to your profession. I trust you are successful, and have much to lose. Don’t risk anything. Get yourself some incorporation help, or visit Socrates, where you can get the documents you need to do the entire process yourself for around $50 bucks.
Regardless of the route you take, I recommend you always maintain detailed records of your business activities, especially if you are going to claim business activity (income and loss from business operations).
And finally, even if you think I have it all together and that I am the smartest person in the world (which I hate to disappoint you but I am not), ALWAYS consult a professional before doing anything legally meaningful. And that professional isn’t me. Consult with your lawyer or CPA today!