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June 3, 2022

Determining Whether to Incorporate Your Contracting Business

As you're getting started with your contracting business, there are a few financial and related details that may play a major role in your future. One of these is the kind of business arrangement you're going to utilize, and an option many contractors consider in this realm is that of incorporating their business.

At Contractors School, we're happy to assist clients with a range of contracting business setup services, including helping you with paperwork, CPA needs, business entity selection and more. What is a corporation, what are the benefits of incorporating your contracting business, and what are some other options you have available to you here? Let's take a look.

Basics on Corporations

A corporation serves several purposes for business owners, and one of the most notable is allowing separation between yourself and your business. This can offer some key protections, particularly if your business is sued - in this case, your personal assets may be safe from seizure.

Another important detail here has to do with taxes. A corporation is a separate entity from you as an individual, and it will file its own taxes. This could potentially lead to lower taxes overall, and it may also make tax planning somewhat easier.

Of course, there are some drawbacks to incorporating your business as well. One is that it can be fairly expensive and time-consuming to set up a corporation, particularly if you're doing it on your own. In addition, corporations do have to follow certain rules and regulations that other business entities don't, and this could lead to additional paperwork and other requirements.

Types of Corporations

Broadly speaking, there are two main corporation types you might consider for your contracting business:

  • C corporation: The most common type of corporation, this involves filing to incorporate with the state in which your business will operate. Once this has been approved, you'll then file for a federal tax ID number.
  • S corporation: This type of corporation is a bit less common, but it may offer some tax advantages. To qualify as an S corporation, your business must meet certain criteria - including being a domestic business with no more than 100 employees, plus several others. With an S corporation, you file directly with the IRS for your tax ID number.

Both these options could offer key advantages for your contracting business - it really depends on your specific needs and preferences.

Timing of Incorporation

If you do decide to move forward with incorporating your business, when should this be done? This is not an easy question, and will depend on a range of factors. However, in general, it's best to incorporate sooner rather than later - that way, you can enjoy the benefits and protection that come along with this business entity type from the start.

However, there will be other cases where you may want to wait on incorporation. You may be considering one of the other options we'll go over here momentarily for your business entity needs, for instance, in which case it might make sense to stick with that for the time being.

You may also want to wait if you're not yet generating enough income to make incorporation worthwhile. Remember, there are some associated costs with incorporating your business - so if you're not yet making enough profit, it may not be the best use of your resources at this time.

Our next few sections will go over alternatives to incorporation that some contracting business owners may consider.

Sole Proprietorship

For many contracting business owners, the preferred business entity type is the sole proprietorship. This is particularly common for those who are just starting out, as it's generally the easiest and most straightforward business entity to set up and maintain.

With a sole proprietorship, there is no legal distinction between you and your business - meaning you're personally liable for any debts or obligations that your business incurs.

There are some key advantages that come along with this business entity type. One is that it's very easy to set up, as there's no need to file any paperwork with the government - you can simply start operating your business. Additionally, sole proprietorships tend to have less red tape and fewer regulations to follow than other business entity types.

Of course, there are also some potential drawbacks to keep in mind with a sole proprietorship. Because you and your business are one and the same, you're personally liable for any debts or obligations that your business incurs - meaning your personal assets could be at risk if your business is sued or can't pay its debts.

For this reason, sole proprietorships tend to be good for contracting businesses as they just start out - but often, these business owners will eventually decide to transition to a different business entity type as their business grows and becomes more complex.

Limited Liability Companies (LLCs)

Finally, another business entity type to consider for your contracting business is the limited liability company, or LLC. Like corporations, LLCs offer their owners personal liability protection - meaning that your personal assets are shielded in the event that your business is sued or can't pay its debts.

Additionally, LLCs offer a number of other advantages. They're relatively easy and inexpensive to set up, and they tend to have less stringent rules and regulations than corporations. LLCs can also be taxed as either sole proprietorships or partnerships - meaning you can choose the business tax status that makes the most sense for your needs.

There are a few potential drawbacks to consider with LLCs, as well. One is that they can be more expensive to maintain than sole proprietorships, as there are typically more filing requirements. Additionally, LLCs can be more difficult to transition to other business entity types if you decide you want to do so down the road.

For more on incorporation or the other business entity options available to you for your contracting business, or to learn about any of our continuing contractor education or related programs, speak to the staff at Contractors School today.

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