Do I need to incorporate?

"Do I need to incorporate" is a question often asked by small business owners, and often for differing reasons. Will I be able to write off more expenses? Will I be shielded from liability? Should I incorporate in Nevada? Should I form an LLC, a regular corporation, or "closely held" corporation. Should I make a subchapter "S" election? 

These are all important questions. And the answers vary considerably depending on the business owners' operations and goals.

Business expenses are normally deductible regardless of the form of the business. A sole proprietor writes off business expenses on Schedule C on his or her personal tax return. A corporation writes off those same expenses on a separate tax return. Some accountants will tell you, however, that writing off business expenses on your personal tax return (Schedule C) will lead to more audits than writing them off through a separate business entity. But, regardless, forming a corporation will not allow you to deduct purely "personal" expenses.

From the standpoint of legal liability, incorporation can provide significant protection. If you don't incorporate, your personal assets are exposed to liability any time someone acts on behalf of your business. So, if you ask someone to go to Staples to buy something for your business, and they get in a car accident, you are personally liable to the injured party. Incorporation protects you from those types of liability. But, it will not protect you from your own actions. You can also shift to the corporation potential liabilities from leases or vendor contracts. Thus, if you sign a 3 year office lease under the corporation, you are not personally liable to the landlord if the business can't pay the bill, or needs to move. Just don't sign a personal guaranty!

Finally, once you decide to form a corporate entity, many more questions arise, including the corporate form, whether to file as a "closely held" business, where to incorporate, and whether to make an IRS Subchapter "S" election. Those questions will be answered in a future post.