If you’re just starting a new business it can be tempting to decide on operating your business as a sole proprietorship simply because it’s one of the easiest structures to create because you don’t have to do anything to start one.
You just decide to run your business in your own personal name or through a fictitious name. You don’t even have to set up a separate bank account or maintain business records but I strongly suggest that you do.
This particular structure is also called a Schedule C business, because when you file your personal 1040 tax returns the income and expenses for your business are reported on a Schedule C that’s attached to it.
Even though the sole proprietorship is easy there is a great deal of risk that comes along with it. So before you decide to go the easy route let me share with you the three main reasons why you should consider incorporating your business.
Liability is major issue because in a sole proprietorship there’s no barrier between you and your business. If the business can’t pay its bills, creditors will look to you personally to make up the difference. If the business buys a vehicle, you buy that vehicle. If a client gets angry and sues the business, you get sued too! If you have employees and they get into trouble on the job, it’s your trouble, too. You and your business are inseparable. You’re one big target. Even though there’s no cost in selecting a sole proprietorship there’s no protection either.
Anyone who’s ever collected a paycheck knows that you lose 6.2% of the first $106,800 of your gross salary on Social Security, and another 1.45% for Medicare (except Medicare has no cap – you pay on every dime you make.
But what you may not know is that employers are required to match those amounts, along with any state payroll tax amounts. So that’s a minimum of 15.3% right off the top of your income. In the right incorporated business structure you can minimize the hit and avoid payroll taxes on a good portion of that income. If you’re using a sole proprietorship or a general partnership you’re stuck.
According to the IRS’s own statistics, sole proprietorships and general partnerships have a 1 in 7 chance of being audited, versus 1 in 50 or higher for incorporated businesses. The IRS figures that the more casually a business is operated, the more likely it is to have some mistakes in its record-keeping and improper deductions that can be denied or reduced.
Now that you know the main reasons why you should incorporate your business here are the four main types of structures to choose from:
According to entity specialist Megan Hughes of U.S. Tax Aid these are considered “safe” business structures because they offer protection for their owners. Each structure listed is treated as a separate being with its own tax registration with the IRS and state agencies. It files its own tax returns and it can also create its own credit files completely separate from that of its owners.
So before you decide to incorporate your business make sure to take the necessary steps in selecting the right structure that best fits the needs of your business from both a tax and asset protection standpoint.
If you’ve been doing business up to now without a business structure, both the IRS and your state government default your business into either a Sole Proprietorship or a General Partnership so consider incorporating your business and avoid putting your personal credit and assets at risk.
Ready to incorporate your business but have questions? Contact my entity specialist Megan Hughes at firstname.lastname@example.org. Be sure to let her know that Marco referred you!
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Marco Carbajo is a business credit expert, author, speaker, and founder of the Business Credit Insiders Circle. A business credit builder system providing no personal guarantee business credit. He is a business credit blogger for AllBusiness.com, a subsidiary of Dun and Bradstreet and author of “Eight Steps to Ultimate Business Credit” and “How to Build Business Credit with No Personal Guarantee.” His articles and blogs have also been featured in American Express Small Business, Business Week, The Washington Post, The San Francisco Tribune, Scotsman Guide, Alltop, Entrepreneur Connect, and Active Rain.