A lot of experts will tell you, as soon as you start up, “Incorporate!” Well, that’s not the right advice for many start-ups. You need to look at the issue more closely to know if forming an S Corporation, C Corporation, or LLC is right for you, or if you should continue as a Sole Proprietor or General Partner. Often, the main thing you’re told you’ll get from incorporation is “protection” – you’ll be safe from lawsuits. Well, that’s true, but that’s not the whole story. First of all, in many states, incorporating will subject you to a minimum tax; in California, where I work, it’s $800/year, no matter how little you make. That can be a lot more than many small businesspeople just starting up would pay on taxes if they remained Sole Proprietors or General Partners. Then there’s that asset protection. Incorporating means that your own personal assets will be safe from lawsuits – but not those of your business; others can still sue your business and put it out of business. And if you’re worried about being sued for loans or other credit that you can’t pay back, well, if you’re a start-up then you probably had to guarantee them personally anyway, so they’ll go after you, corporation or not. Worst of all, if they go after your corporation and drive it into bankruptcy, then you have no source of income and you’ve lost everything you worked for. No, incorporation alone isn’t the solution. The only way you can protect what you’ve built – not just your own assets, but your livelihood – is to carry proper insurance. For many kinds of business, insurance is relatively inexpensive – maybe just twice that minimum tax – and can give you a cushion against a wide variety of problems and mistakes. So, for many small businesses, it’s not liability that makes them incorporate – it’s either:
  • Credit, because a lender or vendor will only extend credit to business entities, or
  • Sales, because a customer will only deal with business entities
Before you incorporate, while you’re still thinking of starting your business, talk to potential vendors and customers and see whether or not they will work with a Sole Proprietor or General Partnership, or if you need that incorporation. (For instance, many large companies will only deal with vendors that are incorporated.) And then talk to an insurance agent and a lawyer. They’ll tell you if you can protect yourself against the risks you have with insurance, and if you need the additional protection that incorporation can give you. But do the math first! Blindly incorporating every single start-up is a prescription to pay the most taxes – without getting real protection.