Should You Change Your Sole Prop to a Corporation?

There are so many strategic business decisions you’ve got to make as a business owner, and you don’t always know which is the right one for your company. When you’re running a startup, it can be frustrating when you’re unsure of what to do for the benefit of your company.

One topic that comes up often for entrepreneurs is business structure: which one is the best for your business? Should you change from what you’ve got?

By default, your business is a sole proprietorship if you file no paperwork for a different type of structure. Most businesses operate as a sole proprietorship. Being a sole proprietor is a pretty easy way to go, but you don’t get some of the benefits that other options offer.

The two most common business structures are the LLC and the corporation, though in this article we will exclusively talk about the corporation, as it’s the more popular choice for small businesses that want to upgrade from a sole proprietorship.

Why consider the corporation?

As I said, the corporation is a popular business structure for small businesses, specifically the S Corporation (there are other types of corporations, though we won’t go into the others here).

While as a sole proprietor, your personal assets aren’t protected (meaning if your company were sued or debts collected, if the business didn’t have the money, your personal assets could be used to cover the debt), as a corporation, they are.

Once you set up your business as a corporation, your personal assets become completely separate from those of the business. A sole proprietorship sees you and your business as one entity, so the separation that a corporation provides is one terrific benefit.

Another perk to converting to a corporation is the tax benefit. If you choose an S Corp structure, you can take advantage of what’s called “pass through taxes,” meaning you file your personal tax return as normal, and you claim your business expenses on that personal tax form. This reduces your taxable income and may help you pay less in taxes.

S Corps don’t pay corporate income tax, so you don’t get taxed twice (on personal and then business). Note: you do still need to file a specific tax form for your corporation, but it’s a pretty simple document. Ask your accountant about it.

Is the change right for you?

Now that you know the benefits to incorporating your business, let’s address the questions you need to answer to determine if it’s the best decision for you.

Do you plan on being in business for the foreseeable future? If your business has a finite lifespan, such as if you plan to retire soon, you might not want to invest the time and money it will take to form a corporation. On the other hand, if you’re in it for the long haul, it could be a wise business decision.

Are you planning to change where your headquarters are based? If you plan to move your business to another state soon, hold off on incorporating. You’re better off incorporating in your new state once you’re settled.

Do you have personal assets you want to protect? Your home, a boat or any large real estate asset is fair game, should something go wrong and your business has more debts than it can cover. Think carefully about how important it is to protect those assets.

How to form a corporation

Start by visiting your state’s Secretary of State website. There, you’ll find a section devoted to small businesses, including forms and instructions for incorporating. Typically you can submit your application online. It will require some basic information about your company, as well as a filing fee. Most states charge between $100 and $300.

Keep in mind, you may be required to submit certain paperwork (along with a fee payment) annually to keep your corporation in good standing. Called the Statement of Information or Annual Report, this document is simply an update of details on your corporate officers, contact information, etc. Not filing it by the due date may cause you to get charged a penalization fee, so make sure to mark your calendar and submit it on time.

While it requires a little bit of paperwork, financial investment and patience, converting your sole proprietorship to a corporation can provide you with peace of mind, knowing your personal assets are protected. Also, if you can pay less in taxes or have less of a tax paperwork headache each spring, why wouldn’t you take advantage of that?

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