If you’re considering incorporating your small business you’re probably already aware of the main advantages, like protection of your personal assets. In this article I’d like to discuss some of the disadvantages of creating a separate entity for your business. There may be some negative factors you haven’t considered, since we’re not selling legal services we don’t mind talking about them.
Loss of personal Tax Credits
Incorporating your small business might not result in a significant reduction of taxes. As a sole proprietor you may actually be able to take advantage of enough personal tax credits, especially if you have a large family and low revenues. Corporations are taxed for every penny they earn. Unless you’ve got some amazing legal and financial resources able to shift money from one entity to another like huge conglomerates, your operation will be required to pay taxes on all earnings.
Reduced Tax Flexibility
Corporations have far fewer options than solo proprietorships for coping with business losses. For example: If as a solo proprietor your small business incurs operating losses you have the option of reducing personal income for that year. A corporation, on the other hand, is forced to carry operational losses to another fiscal year in order to reduce the entity’s income in previous or following years.
Owners of incorporated businesses are often liable for more than expected
Limited liability is of course the main reason many small business owners wish to incorporate. What no one tells you is that personal guarantees to secure financing often render the owners liable anyway. Smaller small businesses with limited assets often have as much difficulty securing operating loans as individuals. If your business has a considerable lack of assets lenders typically insist on a personal guarantees for loans from the owners themselves using their personal assets in place of the corporation’s. So in the end the owners become personally liable.
Registration expenses associated with incorporating a small business can be prohibitive
Another disadvantage of incorporating over sole proprietorships are initial set up costs. A corporation is a far more complex legal structure and the fees associated with their creation reach into the hundreds of dollars. Over time maintenance fees and increased accounting costs can reach thousands of dollars.
One more tax return to file each year
Just because you have a corporation doesn’t mean that you no longer have to file a personal tax return. The increased accounting fees add up and as mentioned earlier if your corporation loses money, you must continue to pay yourself the same salary and in turn pay taxes on that salary. In addition to an additional tax return as a corporation you’re required to maintain additional paperwork like, corporate meeting minutes and registers of the board of directors their shares in the company.
Before rushing off to form a separate entity for your company consider the seldom discussed negative aspects mentioned above and compare them to the benefits of incorporating a small business like yours to decide if you’re making a cost effective decision. Depending on your operation’s size it may be better to wait another year.