WHAT’S IT ABOUT? Incorporating a new business
KEY TAKEAWAY: Forming a business has its share of responsibilities.
INSIGHT: Consult with a tax professional about which operating structure is right for your business and how you can take advantage of the tax deductions allowed by the IRS.
New Year, New Business
I once worked at a firm that incorporated businesses that specialized in helping non-residents form U.S. companies. The beginning of the year was a busy time for us, as wannabe entrepreneurs decided that it was finally their time to get going on that new business idea. It kind of reminds me of the spike in gym memberships when January rolls around. The idea of owning your own business is still a big part of the American Dream and is what sends residents and non-residents flocking to incorporate new businesses across the United States. After all, setting up a new business in the U.S. is a relatively pain-free process. According to the World Economic Forum’s 2018 global competitiveness report, The U.S. ranked No. 1 in “business dynamism”.
While starting a new business may sound appealing, there are a few things to consider before taking a big leap to become a business owner. Despite the ease, don’t incorporate without any plans or clear intentions of developing your business, as there are responsibilities of business ownership. We’ll take a look at what those are throughout the remainder of this article.
Hobby Versus Consistent Income
Before making the decision to incorporate, it’s probably a good idea to do a bit of testing. You can always test your product or service on family and friends. I’m talking real honest and objective feedback from people that are unafraid to tell you to hold off on building your sweater empire and not to quit your day job. Once you’ve gotten ample feedback, you may want to expand your testing to include fairs, farmer’s markets and using consignment as options or whatever makes sense for your particular business. Hopefully, your activities generate some coin but may wind up as just a hobby in the beginning. Your efforts are bringing in some money, but not enough to cover your time and effort. In other words, don’t quit your day job.
Coconut Cult, the expensive “yogurt” (a jar will cost you about $25) provides a good example of going from hobby to sustainable business. Founder Noah Simon-Waddell launched Coconut Cult after suffering a collapsed lung in 2015. Simon-Waddell found that the steroids prescribed to him wiped out the good bacteria in his gut. He began experimenting in his mom’s kitchen and came up with a concoction of a tangy, creamy blend of coconut milk packed with 15 strains of probiotics. Simon-Wadell first distributed Coconut Cult to family and friends then branched off to local markets, and 2017 expanded to stores across the country.
As a general rule of thumb, if you are generating consistent and measurable income, then it’s time to consider incorporating your business, which has its advantages.
Tax & Filing Requirements
Before getting into the advantages of incorporating your business, I’d be remiss if I didn’t speak on that five-letter word: taxes. The good news is that you may not have to file a tax return unless you reach the IRS threshold for earnings, which changes from year to year. For example, last year a person under 65 filing single did not have to file an income tax return if she made less than $12,000. However, the threshold for the self-employed and freelancers is much lower. Last year, The IRS required that you file a return if you earned more than $400 as a freelancer or were self-employed.
If you decide to run your own business, chances are your tax return just got a little more complicated. There are also state filing requirements and let’s not forget the annual filing fee that each state charges for operating within the state. If you decide that you need to hire an employee, you’ll have to file quarterly payroll tax returns for that individual and anyone else you bring on board.
Advantages of Incorporating A Business
Perhaps one of the biggest reasons to incorporate, at least from a tax standpoint, are the tax deductions for business-related expenses. You should incorporate sooner rather than later if you find that you are spending a lot of money on the production of merchandise or for other expenditures to help grow your business. Your incorporation costs may also be a deduction. Below is a small sample of the expenses that the IRS allows you to deduct as a business owner.
- Rent of business property
- Legal and professional fee
It’s a good idea to get tax advice from a certified public accountant regarding your circumstances, as tax deductions vary based on the operating structure of your business and your personal tax bracket.
Protecting Your Ass(ets)
With the exception of operating a sole proprietorship or partnership, incorporating a business protects your personal assets. That means should your business go into debt or worse yet, become a defendant in a lawsuit, creditors and plaintiffs cannot go after you personally in the court of law. The liabilities of LLCs, C, and S corporations are contained within those entities.
But wait there’s more! Another important aspect of incorporating is that it protects the company’s intellectual property such as copyrights, patents, and trademarks. You can certainly file for a personal patent; however, if you are looking to create value, get the most tax benefits and asset protection mentioned above, then it behooves you to incorporate and file your patent or trademark as a business.
Attracting Talent & Funding
A corporation whether it’s a C or S corporation gives you advantages that the other operating structures like an LLC, partnership, and sole proprietorship do not. Corporations can issue shares to either shareholders or employees, which is significant. If you are a bootstrapping entrepreneur, the ability to offer a stake in your company through shares means that you can use company stock as currency to attract key employees if you can’t afford to pay wages. If funding is what you’re looking for, issuing stock to angel and VC investors is standard practice.
The timing of when you incorporate is up to you. As a general rule of thumb, incorporating earlier in the year gives you time before needing to file a tax return for your business. The following milestones or events are indications that you should probably incorporate sooner rather than later:
- You’re starting to generate consistent and measurable income.
- You are spending a lot of money to get your business off the ground.
- You have what may become valuable assets such as a trademark or patent.
- You need to hire key personnel or have plans to seek funding later down the road.
You may also want to consult with a financial advisor such as an accountant regarding the tax consequences of setting up a business. A professional can help you avoid some common mistakes, particularly on the optimal operating structure for your company, where to incorporate, and deductions that are available.