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The Sole Proprietorship

3 Reasons Why You Don't Need to Incorporate

In the start-up world, one of the most misunderstood aspects is the choice of entity for the new business venture. Everyone hears the terms bandied about…LLC, corporation, partnership, sole proprietorship…but hardly anyone outside of a legal professional or CPA truly understands them, and what they ultimately mean to a small business.

Most new small business owners come in to my office and proudly announce…

“I HAVE AN LLC!”

OK, so that does that really mean? You have set up an entity with the Secretary of State’s office which allows you liability protection. That’s great, but it really means nothing in the land of taxes. You’re still a sole proprietorship (if you are only one owner, and for simplicity, let’s assume you are).

But fear not…all that talk about self-employment tax and the need to incorporate may be premature. Here are three cases when being an LLC taxed as a sole proprietorship may be just fine for you:

  1. The business is a part-time gig – You’re road-testing this new idea of yours, and incorporating is somewhat expensive when you are bootstrapping a new business. If you are a corporate entity, you have a completely separate tax return to file, which also means more expense for you. Remain a sole proprietorship for now, file the tax information on your personal return on a Schedule C, and let things remain simple until it’s time to make a change.
  1. The business is profitable, but you plan to fund the heck out of a retirement plan – There are SO MANY great ideas out there for sole proprietors when it comes to funding a retirement plan. I mean, there’s the SEP, the Solo 401(k), and the Simple IRA to name three. Funding plans such as these can greatly reduce your tax exposure, but you need cash at your disposal to make the contributions. This is where we come in, by going over the pros and cons of each plan, contribution limits, and whether or not the plan can grow with you as the business grows.
  1. You’re the only owner, you always will be the only owner, and you abhor paperwork and compliance – Hey, I get it. Taxes and the requisite work that goes into keeping books and records aren’t pleasant for small business owners. Plus, you tell me that you’ll always empty the bank account of profits at year-end. In that case, it may be just fine for you to remain a sole proprietorship for now. Pay the self-employment taxes on whatever profit is left (since you would have taken it all out in payroll anyway, had you been incorporated), fund a retirement plan if you can (see number 2 above), and rest easy in the fact that you are working in the simplest business form out there. Take that, Corporate Minutes book!

It’s very easy to think that one type of business entity fits everyone, and I have to say that most of our clients are S-Corporations these days. But they didn’t always start out that way. Beginning at the beginning is sometimes the best way to do it, and the sole proprietorship paired with the LLC election is a great place to start.

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