By: Denise Camacho, Senior Accountant
Many businesses start as sole proprietorships because of the minimal paperwork and low set-up costs. However, there are many reasons you should consider incorporating your small business.
One of the benefits of incorporating your business is limited liability protection. Sole proprietorships offer no liability protection. In a sole proprietorship, there is no legal separation between the owner and the business.
This means that the owner’s assets – such as their personal bank accounts, home/property, vehicles, etc. – can be used to satisfy the business’s debts and obligations. However, if you incorporate your business, your personal assets may be protected from business debt collection. It is recommended that you obtain the advice of an attorney regarding the issue of limited liability protection and all that it entails.
Incorporating your business also allows you to take certain tax advantages that are not available to sole proprietors. If you incorporate as an S Corporation, you can reduce some of the self-employment tax you would normally have to pay as a sole proprietor.
Sole proprietors must pay self-employment tax on the net income of the business. As an S Corporation, any corporate income in excess of your salary is not subject to self-employment tax. However, it is highly recommended that S Corporation owners continue to pay themselves a wage that is comparable to the market wage for their services to the corporation.
In California, S Corporations can take advantage of the passthrough entity tax election. What this means is that, for taxable years beginning on or after January 1, 2021, and before January 1, 2026, qualifying passthrough entities – such as an S Corporation – may elect to pay an entity-level state tax on income.
Qualified taxpayers will then receive a Federal deduction and a California credit for their share of the entity-level tax, reducing their Federal and California personal income tax. Thus, taxpayers receive a double benefit of reduced flow-through income and a credit on their personal tax return.
Finally, incorporating gives your business transferability and perpetuity that is not available in a sole proprietorship. By incorporating, you create a legal entity that exists indefinitely.
Incorporating also makes it easier to attract investors because it ensures that the business will continue operating seamlessly even if the original owners or founders change or pass away.
Incorporating can be the first step in succession planning by providing a clear framework for ownership transfer and continuity of operations in the event of key personnel changes or transitions.
Incorporating your small business offers a range of compelling advantages. We recommend that you obtain the assistance of an attorney to incorporate your business. By taking this step, you can position your business for growth, stability and long-term success.
Denise Camacho is an Enrolled Agent with the IRS and has experience in bookkeeping, individual income tax returns, corporate tax returns, partnership tax returns, non-profit tax returns, sales tax, and payroll tax. Denise graduated from UCLA in 2013 and has been with Osborne Rincon CPAs since 2019.