Dear Consultant,

For the last eighteen months I have been doing contract architectural work for a number of clients.  I’m wondering if I should set my business up as a corporation.  Currently I do my own taxes and keep things simple, but I’ll incorporate if it makes sense to do so.

There are a number of reasons why a business should incorporate, these reasons usually relate to taxes and liability.  There is a point in the life of most profitable, growing businesses where incorporating makes sense, but for small businesses it isn’t always a great idea.  Depending on what jurisdiction you operate your business, this decision can be made more or less complicated based on your local laws.

Shareholders of corporations enjoy limited liability for the actions of the corporation.

First let’s discuss the issue of your own personal liability.  When you incorporate your business, that is switching it from a sole-proprietorship into a corporation, the business becomes a separate entity.  This separate entity can own property, take on debt, be sued and have its own rule (articles of incorporation).  If you have no partners or investors then you’d likely be the only shareholder in this company, and shareholders of corporations enjoy limited liability for the actions of the corporation.  This is frequently perceived to be advantageous because if the business goes bankrupt, you as the primary share holder may not be held financially liable for debts incurred during the operation of the business.  Similarly, if your company is sued then you may not be personally named in the lawsuit, only the corporation.  For small corporations though, where the company is transparently operated by you, you’d be asked to personally co-sign any debt and you would likely still be personally named in the case of litigation.  So the limited liability afforded to corporations is certainly not a way to completely shield you from financial or legal risk.

In almost all jurisdictions, corporations pay less in taxes than do individuals.

As for taxes, in almost all jurisdictions, corporations pay less in taxes than do individuals.  So if your business is currently setup as a sole-proprietorship or if you’re simply operating the business under your name, then you’ll be taxed at your own personal tax rate.  If you are making significant profits and don’t have much in the way of expenses to offset your income, then there could be tax advantages to incorporating.  This is definitely a decision that would be taken in the context of advice from a tax accountant.

Incorporating introduces some overhead and complexity that may not be necessary.

By virtue of the fact that you’d need to engage with a tax accountant brings me to my next point.  If you are currently doing your own taxes, and you’re not billing significant income through your business, then incorporating introduces some overhead and complexity that may not be necessary.  If you choose to incorporate, you’ll need to pay for the incorporation process – the cost of which varies depending on where you live, but it is frequently a non-trivial amount of money.  Each year when submitting taxes, it would be advisable to hire an accountant to complete your annual tax forms.  While not always complicated if you have a simple tax claim, corporate taxes are different from what you’d be used to and there is room for error.

This is a complex question that certainly depends on the specifics of your situation, but there are pros and cons to creating a corporation for your small business.