Overview: To incorporate or not to incorporate? This is the question many self-employed entrepreneurs ask themselves when starting a new business. The truth is, incorporating a small business is an important decision and a complex one. So what’s the right direction for your business? Read on for some useful info!
Are you an independent small business owner, just starting out and looking for the best way to manage your company? Well, have you considered incorporating your business? Not only does it provide liability protection, but it can also offer some pretty sweet tax advantages that can make a big difference to the bottom line of your small business!
Think about it – when you incorporate, you create a whole new legal entity that is separate from you as an individual. This means that your business can own property, sign contracts, and even pay taxes on its own income!
As an added advantage, you can potentially reduce your personal liability for business debts and lawsuits. That means your personal assets are protected, and you can breathe a little easier.
But that’s not all! By incorporating your business, you could also be eligible for some serious tax benefits. When filing taxes as a corporation, you may be able to deduct expenses such as salaries, wages, benefits for your employees, rent, utilities, and other business-related costs. That means more money in your pocket and less going to the IRS.
Incorporating your small business can be an effective way to take your business to the next level, protect yourself from personal liability, and save some serious cash on taxes.
What Is Incorporation?
Before we dive deeper into the benefits, let’s look at the basics of incorporation. Incorporation is simply the process of forming a corporation, which is a separate legal entity from its owners. When you incorporate your business, you’re creating a new legal entity — a corporation, which has its own legal rights and obligations, and can enter into contracts, sue or be sued, and own property.
Incorporating your small business has many benefits. Let’s get into those now.
Tax Advantages of Incorporating Your Small Business :
Lower Tax Rates
One of the main tax advantages of incorporating your small business is the lower tax rates. When you incorporate your business, you are creating a legal entity that is taxed separately from you as an individual. This means that the corporation pays taxes on its income at the corporate tax rate, which is often lower than your individual tax rate would be.
For example, in the United States, the corporate tax rate is currently 21% for federal taxes. By contrast, the highest individual tax bracket rate is 37%. This means that if you incorporate your business, you could potentially save money on income taxes by paying the lower corporate tax rate.
Please note, however, that the tax rates for corporations vary by state. Therefore, it’s important to consult with a tax professional to determine the tax advantages of incorporating your small business in your specific location.
Tax Deductions
Another tax advantage of incorporating your small business is the ability to take tax deductions. When you incorporate your business, you can deduct expenses related to running your business from your taxable income. This includes expenses such as rent, utilities, equipment, and salaries.
In addition, corporations can deduct expenses that individuals cannot. For instance, corporations can deduct the cost of health insurance premiums for employees, which can be a significant expense for small businesses.
By taking tax deductions, you can reduce your taxable income and potentially save money on taxes. However, it’s important to keep accurate records and receipts for all expenses to ensure that you are able to take advantage of all available deductions.
>> Related Reading: Home Office Tax Deductions: What You Need to Know
Retirement Benefits
Incorporating your small business can also provide retirement benefits for you and your employees. When you incorporate your business, you can set up a retirement plan, such as a 401(k) plan, for yourself and your employees.
By setting up a retirement plan, you can make contributions to the plan and deduct those contributions from your taxable income. This can reduce your tax liability and help you save for retirement.
In addition, offering a retirement plan can be a valuable benefit for your employees — which means it can also help you attract and retain top talent!
Capital Gains Exemption
This is one to consider if there’s a good possibility that you might sell your business someday: Incorporating your small business can provide a capital gains exemption. When selling your business, you may be eligible for certain tax breaks that can help reduce or defer capital gains taxes. There are various laws allowing for these tax breaks, each with their own guidelines, criteria, and regulations.
As is always the case with tax-related matters, it’s important that you consult with a qualified tax professional to determine your eligibility and ensure that you comply with all necessary rules and regulations.
It’s Easier to Raise Capital
Incorporating makes it easier for your small business to raise capital and apply for a loan by granting a sense of legitimacy to your business. When you incorporate, it also means you’re opening up a bank account and starting to build a line of credit — which, for a small business owner with plans to grow, is a necessity.
Limited Liability Protection
While not directly related to taxes, limited liability protection is an important benefit of incorporation. When you incorporate your small business, you’re creating a separate legal entity that’s responsible for its own debts and liabilities. This means that your personal assets are protected from lawsuits or other legal actions against the corporation.
By having limited liability protection, you can reduce your risk and potential financial loss. With this, you’ll also have peace of mind that allows you to focus on growing your small business and increase your revenues!
>> Related Reading: Limited Liability Definition: How It Works in Corporations and Businesses
Access to Funding
Incorporating your small business can also make it easier to access funding from banks, investors, or other sources. This is because corporations, with their distinct legal identities, are seen as more credible and stable than sole proprietorships or partnerships.
By having access to funding, you can invest in your business and potentially grow it more quickly. This can lead to increased profits and potential tax savings.
A Professional Image
Incorporating your small business can also improve your professional image and reputation. By having a separate legal entity, you’re showing that you’re serious about your business and are committed to its ongoing success. This can help attract customers, clients, and employees.
By having a professional image and being taken seriously, you can potentially increase your revenue and profitability, which can lead to tax savings.
Personal Asset Protection
There’s no doubt that starting a business can be an exciting step, but with the excitement comes an acknowledgement of the reality that problems can arise — and unfortunately, businesses sometimes fail. This is where one of the benefits of incorporating your small business comes into play.
By incorporating your business as Limited Liability Company (LLC), or a C or S corporation, you’re protecting your personal assets from business debts. In a worst-case scenario, if your business falls into ugly situations and faces hard times, your personal property will be off limits to collection agencies. Simply put, you won’t have to worry about losing your home because you have failed to pay your business loan (barring any developments so extreme that they require you to sell your property voluntarily).
On the other hand, if you haven’t incorporated your business, your personal assets will be linked automatically to your business. This will include your car, home, investment accounts, and all the assets you obtain in the future. If you were to file bankruptcy within your business as a sole proprietor, your accounts would be used to repay your debts.
Or even worse, if you were to file personal bankruptcy, your business would be considered an asset that could be liquidated to repay your debts. Incorporation protects your business from all these scenarios!
In Summary
Incorporating your small business has many tax advantages that can benefit you and your business. These advantages include lower tax rates, tax deductions, retirement benefits, income splitting, capital gains exemption, limited liability protection, and some other mentioned above.
By incorporating your small business, you can potentially save money on taxes, reduce your risk, and grow your small business or startup more quickly. This can lead to increased profitability and potential long-term success.
A tax professional can guide you through the necessary steps of incorporating your small business and ensuring that you are taking advantage of all tax benefits available to you, while complying with tax laws and regulations. We at Prospect Financial would love to assist you on your journey through the world of business finances. We love working with small businesses and helping them achieve their goals. Contact us today to let us know how we can help you!
