By David M. Warrick, CFP
Incorporation is the next step in the evolution of your business. The laws for incorporation vary from state to state, but incorporating is definitely something to consider to provide protections for you and your business.
1. Liability. This is the primary issue because in a sole proprietorship, there’s no safety net between your client and his or her business. If the business can’t pay its bills, creditors will go after him or her personally to make up the difference. If the business purchases a vehicle, your client purchases that vehicle. If the business gets sued, so does your client. If employees run into trouble on the job, so does your client. Your client and his or her business are inseparable. Even though there’s no cost in choosing the route of sole proprietorship, there’s no protection either.
2. Taxes. With every paycheck comes the hard-hitting reality of losing 6.2 percent of the first $106,800 of gross salary on Social Security and an additional 1.45 percent for Medicare (except Medicare contains no cap – you pay on every dime you make.) But what your client may not know is that employers are required to match those amounts, along with any state payroll tax amounts. So that’s a minimum of 15.3 percent right off the top of your client’s income. The right incorporated business structure minimizes the brunt and avoids payroll taxes on a good chunk of that income.
3. Audit Risk. The Internal Revenue Service (IRS) cites in its own stats that sole proprietorships and general partnerships have a 1 in 7 chance of being audited. The IRS cites 1 in 50 or higher for incorporated businesses. The message here is that the more casually a business is run, the more likely it is to have some recordkeeping errors.