Why You Should Consider Incorporating Your Side Hustle

Let’s say you are thinking of starting a side hustle or already have one up and running. Should you incorporate it?

If you want to scale your business and possibly sell, then I would recommend incorporating. Not to mention you can take advantage of some of the tax benefits of having a corporation. However, if you are starting a side hustle as a temporary business or want to keep it small and avoid the administrative costs involved in incorporating, then keeping it non-incorporated is also an option.

Here’s everything you need to know on incorporating a side hustle.

Advantages of Incorporating

1) Protects Your Personal Assets

A corporation is a separate legal entity. As such, a corporation can own property, carry on business, incur liabilities, and sue or be sued.

Incorporating your side hustle protects you from unforeseen circumstances. Let’s say you shovel sidewalks in the winter and someone slips and breaks their leg and decides to sue you. If you have incorporated your side hustle, your side hustle assets are separate from your personal assets and you will not be held personally responsible.

2) Increases Your Credibility

If your side hustle is something you are looking to scale up and potentially do full-time, look to incorporate. Having “Inc.” or “Corp.” after your business name conveys credibility and stability to customers.

3) Tax Deductions

As a separate legal entity, a corporation is taxed on its profits. These taxes can be reduced by qualified business expenses, including operating expenses, marketing, and advertising, travel, and other costs of making a profit. While you can deduct many of the same expenses with a sole proprietorship, there are more business tax deductions than personal write-offs available to you if you incorporate. If you conduct work out of a spare bedroom in your house, you may be able to claim the home office deduction. If you use your personal vehicle for business trips, the vehicle deduction may be used.

Here’s a list of potential business expenses that may be used to reduce your corporate taxes in the U.S.:

  • Start-up costs up to $5,000
  • 50% of business-related meals and entertainment
  • Operating expenses including everything from computers to pens
  • Employee expenses such as health benefits and employee salaries
  • Charitable contributions
  • Insurance
  • Interest on mortgages and loans
  • Depreciation
  • Rent on business property
  • Utilities
  • Legal and professional fees

Save your receipts and organize them for easy reference in the future. The IRS can often ask you to prove the deductions and the last thing you want is to have claimed an expense and not be able to back it up (tax fraud!). Whether your business will be taxed less than having a sole proprietorship depends on your situation. Contact a tax professional to see if incorporating makes sense to you.

4) Raising Money Is Easier

Corporations have an easier ability to raise money by equity financing, which involves selling shares in the corporation to angel investors or venture capitalists. Though important to note, by selling shares you are reducing your percentage of ownership in the company. You should ask yourself, is it better to have a smaller portion of a bigger pie or a larger portion of a smaller pie? Jeff Bezos, CEO of Amazon, owns 16.3% of his company and he’s worth over $100 billion.

5) Receiving Dividends

If you decide to incorporate and take dividends from the business versus having a salary, you will be able to lower your tax bill as dividends are taxed at a lower rate than salary. Taking a salary from the business, on the other hand, is 100% taxable. Note, however, C-Corporations are subject to double taxation of corporate profits when income is distributed as dividends. Double taxation occurs when the company first pays taxes on its earnings, and then further taxes are paid on the dividends received by the shareholder. This can be avoided by electing S corporation tax status with the IRS, but by going this route you are limiting your appeal to venture capital firms looking to invest due to an S-Corporation’s unique requirements.

Paying dividends is relatively simple. You can write a check to yourself from the corporation and at the end of the year, update your records and prepare a director’s resolution for the dividends paid.

6) Easier to Sell

If there’s a day where you want to sell your side hustle, being incorporated makes it easier. This is because:

  • Corporations are easier to track and manage from an investor’s point of view than a sole proprietorship with the additional reporting requirements.
  • Investors feel that corporations are more stable due to its unlimited lifespan and increasing reporting.

7) Privacy

When you incorporate, you gain a level of privacy that you would not have when running your side hustle. All of your business affairs are private and kept confidential unless you choose to disclose them.

Disadvantages of Incorporating

While incorporating provides many advantages to a side hustle, be aware of some of the disadvantages.

1) Cost

There are typically four types of fees to incorporating: fee to file the articles of incorporation with the Secretary of State; a first-year franchise tax prepayment; fees for various governmental filings; and legal fees. In total it can cost anywhere between $1,450 to $2,150 to incorporate or more, so keep this in mind.

If you live in Canada, you will be expected to pay a fee for federal incorporation of $275, provincial incorporation, which differs from province to province but ranges between $350 to $450, and legal fees.

Filing Articles of Incorporation

This is required when starting a corporation. This can be a flat fee, or dependent on how many shares authorized, or a combination of both. Secretary of State Offices usually charges between $100 to $250 for filing fees, depending on the state you live in.

First Year Franchise Tax Prepayment

A franchise tax is a fee paid for the privilege of doing business as a corporation in that state. This fee can range between $800 and $1,000. Not all states charge this tax, with Nevada being an example, giving an incentive for incorporating there (although it is recommended to incorporate in Delaware).

Government Filing Fees

Corporations are required to pay between $50 and $200 in government filing fees. This is in addition to the fees paid to the Secretary of State.

Legal Fees

While you can incorporate your company yourself, if you make a mistake it might not hold up in a court of law if the business is under a legal investigation. Law firms can range in costs, usually between $500 and $700 but can be as high as $5,000 depending on the complexity of the application and number of shareholders.

2) Double Taxation

As previously mentioned, C corporations have the potential to result in “double taxation.” Double taxation occurs when a company is taxed on profits and then again on the dividends paid to shareholders.

3) Required Structure

When you form a corporation, you are required to follow all of the rules outlined by the state when you file. This can include management of the corporation, accounting practices, and operational requirements.

4) Paperwork

An incorporated business needs to have financial records, notes at meetings, a share register, file tax returns, have bank account records and needs to be audited. You will not be able to mix your business and personal funds under the law when your side hustle is incorporated.

5) Lack of Ownership

When you create a separate legal entity, you need to have separate credit and bank accounts for your business, which I recommend for your side hustle regardless if you incorporate or not as discussed in my book, Kicking Financial Ass.

6) Difficulty Dissolving

If you decide to wind down your business, it can cost as much money as it did to set up to complete the necessary procedures.

7) Losses in an Incorporated Business Cannot Be Personally Claimed

Ideally, your side hustle is not going to lose money. That said, most new businesses have losses in their first few years. If you choose to incorporate your side hustle immediately, you will not be able to use losses personally towards your personal taxes. The losses rather will be retained by the corporation and be used against future corporate taxes. This should not be a concern since starting a side hustle is supposed to add to your income, not detract from it.

How to Incorporate a Side Hustle

If you live in the U.S. you’ll need to choose between entity types such as an S Corporation, C Corporation or LLC, and select a jurisdiction such as your state of residence or Delaware. In Canada, you need to determine which province you want to incorporate in, or if you want to incorporate federally. You also need to think about how many shares to authorize in your new company, and how to split it across the founders. And then finally you need to get all the documents executed, which may or may not involve lawyers.

An alternative is to use an online service like Clerky, which is used by a lot of Y Combinator companies to incorporate. Clerky takes the manual effort, inefficiencies and pain present in the usual incorporation process and breaks it down into a couple forms to fill out.

Clerky advertises itself as the “easiest way for startups to get legal paperwork done safely.” They help automate all the paperwork, from formation to fundraising to hiring. Their fees range from $99 for incorporation as a Delaware C-corporation, the standard for high-growth start-ups, to $299 for post-incorporation setup which includes electing directors, adopting bylaws, and issuing stock.

Jurisdiction

In Canada, you can incorporate provincially or federally. It is recommended to incorporate federally so you can do business across Canada under the same business name. Otherwise, there is no guarantee you will be able to get the same name for your business for each province. There are extra work and money involved to incorporate federally; you need to register your business in every province in which you do business and comply with the corporate filings required by the federal Director of Corporations Branch and all filings required by the provinces in which your corporation is registered in.

In the U.S. LLC’s and C-Corporations can be registered in any of the 50 states plus the District of Columbia. You have three options to choose from:

1) Home State

If you have an LLC, incorporating in your home state is fine. However, most VC’s and investors look at investing in companies that are incorporated in Delaware.

2) Delaware

This small state has developed laws that are business-friendly and is home to a lot of major corporations. As such, lawyers, investors, accountants, are familiar with Delaware laws and regulations.

3) Offshore

One potential reason for incorporating offshore, in the likes of the Cayman Islands, is for a lower tax rate. As a start-up, however, your tax rate is likely to be low in any case, so may as well incorporate in Delaware. Once your business has grown then start thinking about tax optimization.

Legal Disclaimer: The views expressed by Mr. Dumont on Money Sensei are solely his and not intended as investment advice nor a guarantee of any financial return. Mr. Dumont is not an investment or tax professional, so the information contained on the blog is not a substitute for professional advice. The contents of this blog are accurate to the best of his knowledge at the time of posting, but rules and laws are ever-changing. Please do your research to confirm that you have the current information.

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