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Ask Slashdot: When Is It a Good Idea To Incorporate?
First time accepted submitter stairmaster writes "A couple of months ago I came across an opportunity to supplement my income by doing some consulting work (read mobile app development) on the side. It appears that I will be doing this work for some time and my question for you is this: is it worth it to incorporate as a business? I know that the answer to this question is extremely dependent on circumstance but I'm interested in your experiences. Have you been in a similar situation, and if you have how did it work out for you?"
If you have any assets at all, it's a good idea to incorporate to shield them from lawsuits. (It puts the Limited in Limited Liability)
Two main reasons to incorporate are liability and taxes. Liability probably isn't a big problem for you. Taxes come down to how much for how much. There are costs associated with incorporating, including your time, separate bank account, state and federal filings, etc. If you incorporate, do it because the tax savings clearly outweigh the costs.
Also, don't bother with a corporation (S or C). If you do this form an LLC. There are many advantages which you can google if you are really interested.
It limits your personal liability. If you are doing consulting, there is always the possibility that you will err and have someone come after you. Better for them to come after your business than yourself personally and possibly lose your home and other belongings. (They still can but it does make it harder.) It is cheap and easy to incorporate and I can't think of many downsides other than trying to save the $50....
I'm an S-corp and there are huge benefits in tax write offs compared to filing as a 1099, but filing as an S-corp sucks, an you will need an accountant. I would go to an S-corp as soon as you think you are making enough to pay and accountant about $1k a year or are buying or spending good money on anything that could be considered work related, i.e. computers, cell phones, car expenses.
You may just want to consult an accountant on the decision as they can tell you the exact benefits after looking at your situation.
Not when it involves legal matters. Talk to an accountant or a lawyer.
Do you even lift?
These aren't the 'roids you're looking for.
I've been running my own consulting gig via an LLC since 2006. It does have some advantages and is cheap to set up. (Cost me $125 filing fee with the secretary of state's office.) Two things I'd advise:
1. Talk to your insurance agent and buy an umbrella/general liability insurance policy. There's an "errors & omissions" kind of policy that might be perfect. But a general liability may suit you also (it's what I have). But you should definitely talk to the agent about it.
2. Talk to an attorney. Pay $75-$100 for a one-time consultation with an attorney and get their advice on what kind of business model suits you best. The LLC worked best for me. It may be right for you but I can't say. Maybe there are specific advantages to an S-Corp in your case. I don't know. But an attorney you pay to help you make the decision should.
You may also want to talk to an accountant about it. I skipped that part and many people I know in similar situations think I'm an idiot for doing so.
I've owned and maintained an LLC for about the last 3 years. I own 99% of it and 1% is controlled by my father. I did this so I could continue to maintain the protection that the LLC structure offers. In the event that I would ever get sued my personal assets should be shielded from the lawsuit. (Not that I plan to get sued but you can never be too careful).
I was able to incorporate in the State of Pennsylvania (where I live) for a filing fee of $125. I was also able to to register for an EIN with the IRS for free. From there I opened a bank account and got moving. I do limited consulting from time to time as well as manage a couple of servers for some folks. I keep everything totally separate. At the end of the year I work with a local accountant who charges me $125 to $200 to complete my LLC taxes with the State and the Fed.
There are some inherent benefits to having an LLC. I'm able to purchase business equipment such as laptops, computers, supplies, etc... with pre-tax money which lets my dollars go much further.
Additionally other businesses automatically seem to take me more seriously when I reach out to them for software, equipment, services or as a potential client.
If you are already tracking your spending it's honestly not a lot of work. You just have to keep track of your income and expense for your business. If you are small a spreadsheet and some folders for paperwork will work just fine.
The LLC structure has been extremely easy for me to manage and most months I don't even think about it. The only advice I have is avoid those "we incorporate you" websites. Chances are pretty good if you do a little bit of research you will be more then able to handle this yourself. Also reach out to the state that you are incorporating in, you'll be surprised at how helpful they can be with the process.
Let me know if you have any questions or concerns, I'm happy to help.
The down side is that it takes a lot of paperwork, a relationship with a lawyer and an accountant and your taxes get a lot more complicated. Also, the IRS is well aware that a corporation makes a good tax dodge, so you have to be careful to keep good records and not run afoul of them. And be able to prove to them that you're on the level when they come asking. They probably WILL come asking.
I'm trying to teach myself to set people on fire with my mind... Is it hot in here?
When I asked my lawyer this question, his advice was that for a one-man shop, incorporating does not significantly affect your liability. If you are negligent, then they can come after you, whether or not you have incorporated. I know this differs from the word on the street. I made him say it several times, because it was not the answer I expected. Where it makes a difference is if you have partners. If your partner is negligent, then a corporation or LLC can shield you. BTW, he did not bill me for that consultation. There is really no excuse for asking a large group of non-lawyers instead of calling one on the phone for a few minutes.
24 people have posted before I did. They all had some input. From a US Legal perspective none of them adressed the real issue.
"When to incorporate?" -- When you need to.
The purpose of a corporation is to create an "entity" (some mistakenly call this "person") that is the true wage earner,
whose assets are the only ones impacted by the acts of the corporation.
If you're a sole practitioner, and every dollar that comes in goes to you, a corporation will not shield your personal assets from anything.
For a sole practitioner to effectively use a corporation you'd need to ...and finally... the expensive part...
- make sure the corporation collects all fees and pays all expenses related to the consulting work AND NOTHING ELSE
- make sure the corporation 1099s you or W-2s you or in some way tax-wise indicates it pays you legal wages, not under-table money transfers
- never comingle coporate resources and your own needs (in other words, no corporate paying your gasoline refill enroute to the customer or your lunch)
Have D&O E&O insurance.
If you're willing to go through all that, a corporation can shield your assets.
For one guy, far cheaper not to be a screwup and not get sued, and not mess with any of that.
The law is pretty clear. If it's a separate entity ("person") then it needs to be separate. If you keep it so, and keep it insured, it will protect you.
E
P.S. All I've said is specific to United States corporation and contract law.
I've had a couple businesses where I incorporated right off the bat. Ultimately, it was expensive and the overhead hurt my business. Like you, I am in a consulting business at the moment. Three months into it, I still have not registered the business.
I don't need the overhead, I don't need the liability protection, and I don't need to waste time right now filling out forms and keeping the State happy. I need to focus on keeping my customers happy and making money. If I manage to net $10K or more this year on this side business, then I'll register. Otherwise I would just be making a lot of extra work for myself.
Make sure that your business is going to succeed - because unregistering a corporation is expensive and usually even more time consuming that registering it in the first place.
If you read slashdot, you know that corporations are evil. So, clearly, the time to incorporate is when you decide to become evil.
Note to ACs: I usually delete AC replies without reading them. If you want to talk to me, log in.
If you are working as a consultant, then the biggest advantage of incorporating will be in tax savings.
In Canada (Ontario specifically) there is a break-even point around $42k/yr income, where the personal income tax and corporate income tax (and accountant fees, etc.) you pay will be approximately equal. Above $42k/yr income, the corporate tax will become less and less compared to personal tax. This is due to the fact that the corporate tax rate is fixed at 16.5% (until $500k or $1M annual income... I can't recall) while personal tax rates have brackets that increase as you make more money.
To take an example from my past, the last year before I incorporated I made roughly $86,000 and paid about $22,000 in personal income taxes. The accountant that helped me incorporate did some calculating, and if I were incorporated, the corp would have had to pay only about $13,000-14,000 in taxes.
There are some costs associated with running a corporation. There are the initial costs of setting it up, usually between $2000-4000 for lawyers and accountants. Then annually, you will probably have an accountant prepare your corporate taxes, which will cost around $750-2000 depending on who does it and how organized your paperwork is. These are extra hassles that some people find unpalatable, and it is a bit of extra administrative work on your part, but altogether, it saves you thousands and is very much worth it. (Unless you have some kind of ADHD and psychologically cannot deal with paperwork.)
Another tax saving tool available in Canada is that you can make $50k/yr in dividend income, tax free. Therefore, if you and your significant other are both part owners in your newly formed corp, then you can essentially have a combined household (personal) income of $100k/yr, tax free because your corp will pay out dividends to its owners, rather than salary (which is all taxable). You will probably not make exactly $100k/yr tax free (but it will still be around $95k or $98k) because in order to take advantage of various tax credits you have to show some personal income. How this is works is that, whenever you need money from your corp, you just withdraw it. At the end of your fiscal year, you and your accountant will figure out how to label those withdrawals, be it dividends, salary, whatever, to maximize the tax savings. That is how I have been doing it in Canada, anyway, and your accountant will be more familiar with how this stuff works in your area.
The best thing you can do (aside from asking the experts on Slashdot, of course) is to go see an accountant who deals with corporate stuff. Explain to him or her what you are thinking about doing and outline your current situation. Using your 2011 net income as an example, they can then draw up a spreadsheet for you, showing what would be your taxes and other numbers if you had been incorporated in 2011. This will let you know with little uncertainty what is your best course of action.
There are other benefits that come with having a corporation, your corp can purchase the equipment (e.g. laptops, mobile devices for testing, etc.) that you will use to do the service that the corporation sells. This can be recorded as an expense of the corp, which reduces the corporate taxes. In contrast if you bought equipment personally, it would not affect your tax situation at all. This is nice if you like toys, and would like some extra reasons to rationalize their purchase.
In summary, if you plan to make more than $42k (*) this year from your moon-lighting activities, just get it done already.
* $42k, or whatever is the break-even number for the tax system you live in.
People mistakenly believe that incorporation is some sort of "magic wand" that reduces your tax liability and limits legal liability. Unless you meet the VERY STRICT rules for keeping the corporation at an appropriate "arms length" it does none of those things. (And it really doesn't do much for your tax liability even if you do incorporate.) Really, if you are just getting started on your own, insurance is a LOT less of a time sink than incorporation, and time is something any new entrepreneur does not have nearly enough of.
He's _implying_ that it is not related to his regular employment. Need to be pedantic.
None of them can see the clouds; The polished wings don't care.
I did that a while ago.
Before that I workd as "freelancer". That ment a year with a high income led to high taxes. A year with no income had no benefit (well, payed no taxes ofc ...)
Now with my incorporation, the company works as a buffer, safing taxes in the long run.
I'm now no longer "freelancer" but "self employed". My company pays me small wages. So after wages, pension funds and internet/phone bills, the rest teh company makes is profit and taxed. (But to a significantly lower tax rate than above).
From that wages I pay income taxes (in your case you had likely two times wages, once from your original employer and in addition now from your own company).
However: if your company stops app development for a year, and continues paying you, it makes a loss in that year (on top of paying no taxes ofc). That loss, even from several years, is carried into the next year. Your personal taxes from your double income are not affected ofc.
Example: before incorporation I make $100,000 profit like this: // sabatical -> 0 Tax. // only worked half a year -> $6000 Tax
2007: $100000 -> 45,000 tax
2008: $85000 -> 39,000 tax
2009: $0
2100: $35,000
Now my personal income and company is something like this:
2007: $38,000 -> $9,000 Tax / $62,000 -> $19000 Tax
2008: $38,000 -> $9,000 Tax / $47,000 -> $14000 Tax
2009: $38,000 -> $9,000 / -$38,000 no Tax
2010: $38,000 -> $9,000 / (-38,000 from previsous year plus $35,000 earnings this year) - $38,000 wages -> additional $3000 loss -> no taxes
2011: $38,000 -> $9,000 / company starts now with -$41,000 loss.
Well, that is a bit simplified and the numbers are made up, but as a general idea I guess you get it.
You see the total taxes payed is far lower (or in other words, the remaining total money you "own" is much more).
Otoh you have costs to run the company, likely tax counceling, reporting, bookkeeping etc.
You only have to balance, founding costs and running costs of the company versus the buffering effect of the company (saved taxes).
Cost free eBook I read (by iBook/Kobo/Amazon/ObookO/Gutenberg etc.): "The Green Odyssey" by Philip Jose Farmer.
The incentive to incorporate is lessened if you plan on spending all of the cash generated by the business. For then you would have to report all of the income at graduated personal income tax rates.
If you plan to leave cash in the business and not use it personally right away, then incorporating makes much more sense. Here, the amount of combined personal + corporate taxes in the near term would be smaller. The time value of money in the delay of paying taxes works in your favour. What might the business do with its retained earnings? It could invest in assets to grow its own business. It could invest in other businesses.
After breakfast, certainly.
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Thanks you all for your opinions. I definitely will speak with lawyer and accountant friends but it's very helpful to hear about your experiences with the matter. Again thank you very much!
Scenario: I incorporate in the Caymans or Hong Kong or somewhere where ownership information doesn't have to be disclosed to the USA. My bank account and web site are there too. The corporation "hires" me, but otherwise keeps any profit. I pay income tax on my declared income, but have access to the corporation's funds via credit card.
Liabilities? Problems? Legalities? Inquiring minds want to know!
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My advice....incorporate yourself immediately!!
My advice: don't incorporate. The added burden of accounting and paperwork way outstrips the minor benefits of incorporation unless maybe you're making over about $50,000 per year.
First, as other mention, it limits liability for damage and creditors taking your personal possessions.
No, it really doesn't. If you're looking for protection against, say, a lawsuit for selling a defective product, then yes; or if you plan on buying parts on credit, and aren't sure you are going to be able to pay, sure, it's good protection. But you'd said you'd be doing consulting work. It's unlikely that you would encounter any lawsuits of a type that incorporation would protect against.
Second, this is about the ONLY way to keep more of your hard earned tax dollars. YOU can begin to write off all expenses, mileage (keep a logbook in your car to write odometer settings, easy documentation).
Nonsense. File a schedule C; that allows you to deduct all those things on your personal taxes.
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