If your selling activities on eBay, Etsy, or other online venues are a business for you, consider whether to take the legal step of incorporating. Here are some compelling business and tax reasons why this may make sense for you now.
Protect your personal assets
As an online business, it’s unlikely that you’ll face personal liability or other claims common to brick-and-mortar stores (e.g., alleged violations of the Americans with Disabilities Act), but you never know what claims will arise and how well insurance will protect you. If your business is a corporation, creditors can only look to corporate assets to satisfy their claims. Your home, your personal bank account, and other personal assets are fully protected. (Be aware of a concept called “Piercing the Corporate Veil.”)
Gain credibility with customers
There is a public perception that a corporation is more professional and reliable. Customers, vendors, and lenders think so. Perhaps the reason for this is the fact that a corporation has an unlimited life. The owner may die but the corporation goes on.
Avoid estimated tax penalties
If you are a sole proprietor, a partner in a partnership, or a member of a limited liability company, you usually must pay your income taxes and self-employment tax through estimated tax payments made four times a year. This chore is problematic for some who fail to set aside sufficient cash to cover their tax bills and to remember to make timely payments. In contrast, if you are incorporated, withholding from your salary can be made to cover your tax obligations for the year. (And as an employee of the corporation, there is no self-employment tax; FICA is paid by the corporation and you as an employee.)
Reduce income taxes
Depending on the business’ revenue and your personal tax picture, you may be able to save federal income taxes by being a regular (“C”) corporation. This is because a C corporation is subject to a flat 21% tax rate. In contrast, owners of S corporations, as well as owners of unincorporated businesses, pay graduated rates up to 37% on their share of business income (although they may be able to claim a 20% deduction on qualified business income).
Avoid tax audits
While the overall audit rates on taxpayers are low, the rates on corporations are lower than on individual business owners. Obviously, you want to report income and expenses correctly regardless of your legal entity, but having a reduced chance of being audited can help you sleep better at night.
It may be easier for businesses that are C corporations to expand. They usually have an easier time obtaining loans and attracting investors.
Owners who might be looking for a way out might want to transfer ownership gradually to employees. With C corporations this is easy to do with stock options, employee stock option plans (ESOPs), and other tax-favored transactions. For example, retailers such as online sellers can give employees as compensation what is called “Section 1202 stock.” If they hold onto the stock for more than five years, they don’t pay any tax on their gain.
In deciding whether to incorporate, be sure to factor in state-level concerns. What will incorporating mean taxwise for your business? What annual reporting requirements apply to a corporation?
If you decide to move ahead with incorporation, you can do it yourself by obtaining forms from your state’s Secretary of State or using an online incorporation service, such as LegalZoom or BizFilings. Better yet, you can engage an attorney. The one-time cost of these legal services (usually a flat fee) should not be too much to handle.
Take your time to assess incorporation. As I say in Smooth Failing, business owners are bound to make mistakes from time to time, but certainly avoid them when you can!