One of the most important aspects any potential entrepreneurs needs to consider before opening a home-based business is this: what legal form will my business take? How will I incorporate it? If you are new to the business world, you may not appreciate the importance of this decision at its true value. You may think that you have better things to worry about, such as raising the start-up capital or perfecting your marketing strategy.
Why You Should Not Run Your Business as Sole Proprietor
However…here are a few thoughts to consider. If you do not incorporate your business as a legal entity, you will run it as sole proprietor. Sole proprietorship is a legal and valid way of running a business, but it is not in your best interests at all. For one thing, you will never be able to obtain a business loan if you decide to grow your business. For another, and this is the number one negative aspect of sole proprietorship, your liability is unlimited. If you are sued by a customer, if you do not keep and file your tax documents on time, you can be pursued in court for everything you own: your house, your car, and your savings account.
Practically, there is no delimitation in the eyes of the law between you, as a private person, and your business. Your assets are the business’ assets, and your business’ liabilities are your own liabilities as well. Now that we have got you thinking (and worrying a bit), let us show you some of the ways in which you can incorporate your home-based business in a way that protects your personal assets:
1. Limited Liability Company (LLC)
This form of incorporation is very popular among businesses in the US and worldwide. A LLC business is only liable up to the limit of its assets. That is, if you bought a computer in the name of your business, that may be forfeit in court as a part of compensations granted to an unhappy customer; however, if you bought that computer under your name as a person, it is untouchable.
The downside aspects to incorporating your home-based business as a LLC are:
⦁ In some states (such as New York, for example) the taxes for incorporating a LLC are very high;
⦁ If you move across states, you will need to re-incorporate your business in order to operate it legally;
⦁ You will have to file separate tax returns for your personal income and for your business revenues and, by consequence, pay more taxes.
2. Corporation (C-Corp)
You should only incorporate your home-based business as a C-Corp only if you envision a large scale growth – across states, with several shareholders and multiple branches and offices. C-Corps are the most extensive form of incorporation for legal entities and, as a consequence, there is more paperwork to fill, more taxes to pay, and more requirement for insurance and bookkeeping. Also, if you plan to raise capital for your business through the sale of stocks, C-Corp is the recommended form of incorporation for this purpose.
If you want to run a small- to medium-sized business in your local area, there is no need to opt for C-Corp incorporation. There is no need to pay federal and local taxes on a business which you do not plan to expand (from the point of view of operating headquarters) beyond your state limits.
3. Small Corporation (S-Corp)
S-Corp is by far the most advisable form of incorporation for home based business. As a S-Corp, you operate on the principle of limited liability (your personal assets are protected) and you are taxed at personal income level. There is also less paperwork to prepare and keep throughout the financial year and the initial taxes and fees for setting-up the business are smaller.
However, if you plan to obtain business loans, you will find that traditional lenders are less willing to grant loans to an S-Corp.
Before you make a final decision, you should also consult with a legal and a tax consultant, present the complete situation of the business you intend to run, and obtain qualified, professional recommendations from them.