Why You Should Incorporate Your Small Business

Incorporate your small business

If you are attempting to generate income online and you have not yet done so, you should seriously consider incorporating your business.

There are many different ways in which a business can be structured, and each has advantages and disadvantages.

It is often suitable for small businesses to start out as sole proprietorships or partnerships and become incorporated as the business grows. The structure of your business should fit with your intended objectives as the structure will affect ownership and transfer, taxes, and the ability to get credit.

There are different ways to incorporate your small business

One of the more popular methods of incorporating your small business is the limited liability corporation or LLC. The main advantage is the limited liability of the company. Depending on the type of business, as a sole proprieter, your personal possessions, such as your house and car can be seized to pay the debts of your business, but as a shareholder in a corporation, you can’t be held responsible for the debts of the corporation unless you’ve given a personal guarantee.

With an LLC, your personal assets are protected, as the business structure legally separates the assets of the ownership from the company assets The corporation may be sued (and can even go bankrupt) without loss personal losses. The best protection comes from a corporation with the management and personal ownership are completely separated.

There different forms of incorporating your small business and each carries some degree of inherent risk.

Tax deferral

If you incorporate your small business, you can determine when you personally receive income, which can be a real tax advantage. You can defer receiving income to the period where you will be paying less taxes.

Another tax benefit of incorporating your small business is the ability to split your income. Dividends are paid from the earnings of the Corporation to the shareholders. Shareholders can be passive investors and still receive dividend payments. Your spouse and/or your children could be designated as shareholders in your corporation, which provides the opportunity for income redistribution to those in lower tax brackets.

Raising capital is easier when you incorporate your business

While corporations can borrow and incur debt like any sole proprietorship, they can also raise capital by selling shares which is a big advantage because equity capital generally does not have to be repaid and incurs no interest. Although the ownership of the business owner(s) is reduced as the equity grows the value of the ownership also increases.

There are more benefits available when you incorporate your business

Tax Deduction

If you incorporate your small business, your business may qualify for the small business deduction. This is an annual tax credit that is calculated at the rate of 16% on the first $200,000 of taxable income. This rate may be a much lower rate than that applied to personal income.

Your corporation may grow at a faster rate, because corporations are generally perceived to be more stable, and some business may elect to do business only with corporations, because of inherent liability issues.

The Big Picture for Small Businesses: Recent Data Suggests Small Businesses Remained Challenged

On June 14th The National Federation of Independent Businesses (“NFIB”) released its monthly survey of Small Business Economic Trends and there were a few interesting insights that I wanted to share. The NFIB is a member organization that represents more than 300,000 small businesses in the United States, ranging from sole proprietors to businesses with hundreds of employees. It is important to understand the economic conditions for small businesses because they constitute such a large proportion of the employment base of the economy.

The NFIB survey of Small Business Economic Trends, as reported through the month of May, yielded the following insights:

  • Sales: 25% of all small businesses reported that their top business problem was having weak sales. It’s not simply a question of slow growth, but rather a matter of continual decline. There are still more small businesses that are reporting declining sales than those reporting growing sales, so the trend is still negative.
  • Credit Availability: Access to credit is not one of the most pressing problems for most small businesses. In fact, only 3% reported that credit access & financing were their top problem, and 92% responded that they had no credit problems or additional financing needs of any kind. (In a survey last year, most business owners stated that they wouldn’t borrow money even if it were free because they still wouldn’t have the end demand to justify the increased headcount and new equipment.)
  • Employment: On a seasonally-adjusted basis, there are more businesses that intend to reduce their workforce over than next 3 months than those that plan to hire new workers. This is a disturbing change in the trend, as this is the first month since September of 2010 that there were more small businesses planning to lay-off employees than to hire them.
  • Inflation: 10% of small businesses reported inflation as being their biggest problem, the highest percentage of businesses reporting that inflation was a problem since before the credit crisis. Even more interesting, 31% of all small businesses reported that they are raising their average selling prices for their goods or services, with only 16% reporting that they are lowering prices. This is another change in the trend as small businesses had been cutting prices during the previous two years.

So, putting this all together we see that the average small business has declining sales, is laying-off employees, and is raising prices for its goods & services. These are interesting and unusual business dynamics. A business that is facing declining revenue generally doesn’t resort to price increases to solve its problems!

Sadly, this may be a reflection of the fact that many small businesses are facing significant cost pressures and declining revenues at the same time, but since most small businesses have lean operations to begin with, they may be left with no alternative but to finally pass rising cost pressures through to the end buyer, even in the face of declining sales. Additional recent data is consistent with this view. On June 15th the Bureau of Labor Statistics reported that its measure of “core inflation” had risen more than expected, suggesting that inflationary conditions may be moving beyond food and energy prices and are now spreading to the broader economy.

During the past few years of recession and crisis, the government response has relied on 4 basic strategies: maintain extremely low interest rates, maintain high levels of deficit spending to fill the gap in private demand, create tax incentives for consumers to buy goods, and provide tax incentives for businesses to hire employees and buy equipment. However, it’s readily apparent that most businesses don’t want to borrow money or hire employees because consumers don’t want to buy more goods or services. In fact, many consumers are trying to save money for the first time in many years. Also on June 15th – one day after the NFIB survey – a poll from NBC News/Wall Street Journal indicated that almost half of all Americans believe the U.S. economy is headed back into recession. Regardless of whether or not these respondents turn out to be correct, their own behavior is no doubt one of the reasons for our continued slow economy. People who fear recession are likely to save more and spend less, so to a certain extent the fear of an impending recession has a self-fulfilling effect.

It’s fair to question if our government’s policies have exceeded their usefulness and may be working in a counterproductive manner at this point. For example, if low interest rates do not stimulate credit growth, but do stimulate asset price inflation and higher commodity prices, then it’s certainly reasonable to question if we are deriving a net benefit from current monetary policy. I’m not sure that we are.

At a broader level, the recent small business survey continues to support a rather pessimistic outlook for the remainder of this year. The economic recovery is anemic, small businesses are under extraordinary pressure, energy and food prices are higher, government stimulus is expiring, quantitative easing is coming to an end, state and local governments are cutting spending and laying-off employees and now the federal government appears poised to implement some fiscal restraint of its own. Two years into the recovery, the economy may be approaching a stall point.