The legal formation of a business is a critical decision that needs to be made when you first startup your business. It doesn't mean you can't change the legal form of the business down the road.
You should know why you're incorporating or forming a sole proprietorship before you make the move. And there's plenty to consider.
However, the final decision, of course, is based on what type of business you're starting from a legal and financial perspective. You should think about getting advice from an accountant, lawyer or even an insurance agent.
For something as important as deciding to go corporate or not -- it's time to bring in the professionals.
The number one reason for incorporation is to protect yourself from any liabilities. A business such as construction, for example, is a high liability business -- and one that MUST be incorporated. For the most part, incorporating will protect you, the owner of your company from lawsuit against your personal assets.
By forming a corporation, you are actually not the business (as you are with a sole proprietor.) You are only an "employee" of the business. This is not to say you don't have anything at stake as a corporation. It is your responsibility to protect your business from these liabilities.
But you, the person, are protected. Your house is safe. Your personal savings are safe. Your kids are safe.
You may, however, happen to be in a small business where your liability is very limited because of the nature of that business. For this, the cost of incorporating may outweigh the benefits.
But if you're generating a decent income from your business -- the benefits go well beyond simple asset protection.
Forming a corporation also provides tax benefits that you won't see as a sole proprietor. These include better health insurance deductions, retirement plans and even investment benefits.
Some states make it simple to incorporate without having to go through a lawyer. However, other states make it very burdensome and expensive to incorporate, causing business owners to make the decision based solely on cashflow. If you're just starting out, it's a tough decision to spend a few hundred dollars on incorporating your business versus getting the word out with your first marketing campaign.
Your best option is to do the research and find out what the process is through your state. Don't be surprised to have plenty of questions when you start staring at the forms. You can head right down to the office where your state incorporates and they'll be able to walk you through the steps.
Another option that's becoming more and more popular is forming an LLC.
An LLC will give you the legal protection of a corporation but a lot less paperwork to form and maintain the business. Check with your state to see if forming an LLC is allowed.
Why a Sole Proprietorship?
A sole proprietorship is still the easiest form to setup.
You're literally looking at a drive to town hall where you fill out a short (generic) piece of paper and pay anywhere from $5 to $75 (depending on where you live, of course). At the most, you may end up paying an additional zoning fee if you're going to work out of your home.
The process of becoming a sole proprietor, front to back, is far simpler.
And there are still tax and other benefits to you as the owner. As a sole proprietor, you are your company. The income is your personal income and the debt is your personal debt. You are taxed on your income from that business just as you would any personal income, with the addition of tax advantages.
Many small businesses do not expose their owners to great losses or liability claims, making a sole proprietorship an affordable option. Again, this should be discussed with your accountant, lawyer and an insurance agent.
Even if you decide to file for a sole proprietorship to get your business off the ground for a few years, you can make a decision later whether or not to incorporate.