Why and when to make your side-hustle an official business
Thinking of incorporating your side-hustle? Doing so can be a smart move. Read up on when and why you should incorporate your business
So, you’ve got a bustling side-hustle.
You’ve had one for a while, and lately, it’s been turning into more of a hustle-hustle than a casual income-earner on the side.
If you’re wondering if and when it’s time to make things official and turn your side-gig into a formal business, you’re in the right place.
Today, we lay out five reasons to incorporate your business, plus when to know if the timing is right.
Let’s dive right in, starting first with what incorporating your business means and why you should do it.
5 benefits of incorporating your business
Just so we’re all on the same page, incorporating your business means formally creating a corporation, so it’s a legal entity that’s separate from you, the business owner.
There are a lot of benefits to doing it. Here are just five of them.
Benefit #1: Liability protection
Sadly, there are thousands of reasons why businesses get sued -- some frivolous and some legit.
Take, for example, Backcountry.com, an outdoor clothing retailer that sued several small businesses that trademarked the word “backcountry”.
Or the many businesses that saw lawsuits in the past few years for having websites and apps that were not ADA-compliant.
With unlimited reasons for suing a business, it’s better to be safe than sorry by covering your bases and getting incorporated.
Even if there’s a slim chance of your business being sued, a chunky 43% of small business owners are threatened or involved in a civil lawsuit.
Of course, incorporating your business doesn’t offer you complete liability protection. You can still be liable if you personally guarantee a contract.
If you want more security, consult with your lawyer and follow business laws and best practices (i.e., investing in business insurance) to strengthen your liability protection.
The main takeaway is incorporating your business distinguishes your business activity from you, the owner, and protects your personal assets.
Aside from some legal protection, official business structures offer tax benefits, too.
Benefit #2: Potential tax benefits
Another common reason why businesses incorporate is the tax benefit.
But that’s not to say incorporating your business means a lower tax bill.
The amount of tax you need to pay depends on country, state, and city laws, your business income and expenses, and your business structure, to name a few factors.
But there are business structures that offer financial benefits.
For example, some companies elect to become S corporations, which are corporations that have no more than 100 shareholders and are taxed as a partnership.
This means your corporate income, losses, deductions, and credits are passed to your shareholders for tax purposes, which lets you avoid double taxation -- where you pay taxes twice (personally and as a business) on the same income source.
This is also why entrepreneur Erik Dietrich elected to have his LLC be treated as an S corporation -- for legal and tax simplicity.
(In case you’re unfamiliar, an LLC is another business structure that offers protection over your personal liability, where the taxation is passed through as a sole proprietorship or partnership.)
Also, depending on your annual earnings and how your business is taxed, you may also qualify for the Qualified Business Income (QBI) deduction, which allows you to deduct up to 20% of your qualified business income on your taxes.
If you’re wondering how common this tax benefit is, over 15 million taxpayers claimed the deduction in 2018. So, depending on your tax situation, your business may enjoy the same benefit.
Again, while it’s best to talk to your lawyer and accountant for the specifics, the point here is you can potentially save big time on your taxes by incorporating.
Speaking of finances, formally incorporating your business also makes it easier to access our third benefit -- funding.
Benefit #3: Easier access to loans, credit, and other funding
Another benefit of organizing your side-hustle into an official business is it helps you set up the right business bank accounts, which causes less friction when applying for credit cards and loans.
While 27% of small business owners don’t have a separate bank account for their business, it’s not a wise move and can hurt your business’ financial future.
The reason is having a business bank account makes you appear more legitimate and trustworthy to financial institutions, increasing your chance of getting a loan, credit, or other funds.
Here’s proof: 70% of small business owners who didn’t have a business bank account were denied a loan in the past two years.
Having a business bank account is one reliable source for showing your business’ cash flow data and payment information to a financial institution -- key considerations when they decide to offer credit and funding to small businesses.
Not to mention, a separate bank account makes managing your business’ finances a cleaner process overall.
Basically, having an officially organized business helps grease the wheels when you apply for business bank accounts, credit cards, and loans.
But OK. So far, you’ve got a side-hustle -- if you’re unsure of whether or not you want to be in a full-blown business over the long-haul, read our fourth reason to incorporate.
Benefit #4: Easier to sell the business or change management
Even if you don’t stick with your business forever -- maybe you’d like to one day sell your company or transfer it to a family member -- it’s wise to incorporate your business, so you can sell or transfer your business later on.
Unfortunately, sole proprietorships can’t be sold since they’re not distinct entities from their owners. (Sole proprietorships’ assets can be sold, however.)
By incorporating, you're making it cleaner and easier for you and your business to part ways in the future if you ever decide to sell, transfer, or close it.
By doing so, you’ll be that much closer to joining the 33% of business owners who have an exit plan for if/when they close or transfer their business.
Even if it’s far in the future, having an idea of how to end your business can save you logistical and tax headaches later on.
Regardless of your future plans, while you and your business are still together, there’s another final benefit of officially organizing your business: a more professional vibe.
Benefit #5: Project a more professional impression
Operating as a formally incorporated business can also make you appear more legitimate and trustworthy to clients.
This can lead to more sales, more profitable contracts, and even more respect from your clients and customers. Not to mention, it’ll add to a higher perceived value and likely less price haggling with your clients.
Take entrepreneur, Matt Olpinski, for example.
Matt transitioned his business to an S corporation after 10 years of being self-employed. Among other reasons, he chose to become an S corporation to improve his clients’ perception of his business.
As Matt notes, “1099 contractors are often perceived as cheap commodity laborers, not valuable business partners. That’s why many freelance clients tend to be cheap, demanding, and controlling.”
Forming an S corporation allows Matt to operate in the same way he did as a 1099 contractor while sending signals of higher professionalism that often results in more respect and pay from clients.
Matt now also includes his business name in several key places, like his business website footer and client invoices.
Becoming a formally organized company can add an extra layer of credibility and trust to your company in your customers’ eyes.
Phew. OK. These five cover the benefits of incorporating your side-hustle and making it an official business, but that still begs the question . . . when should you do it?
Let’s get into it.
When to incorporate your business
Situation #1: When you’re starting your business
The first scenario for when to incorporate your business is at the start.
While it’s no secret that sole proprietorships are popular -- with the IRS processing 25.5 million non-farm sole proprietorship returns in 2016 -- you don’t have to start your small business as one.
For reference, there were 30.2 million small businesses in 2018, which means sole proprietorships are one of the most popular business structures by an overwhelming majority.
But popular doesn’t necessarily mean better.
You can avoid the trouble of transitioning from a sole proprietorship into another business structure later by incorporating when starting out.
If you’re wary of incorporating straight out of the gate, one option is to submit a delayed filing, which is when you submit your business registration forms and request that your business not officially be recognized as being open until a later date.
Why delay a filing?
Some business owners do it so they can avoid paying taxes or certain fees in a calendar year. It might also make sense during an inactive period when you’re not yet operating and earning sales.
Delaying filing can also help you start your business on a day that’s easier to work with -- say, January 1 -- so your business affairs are cleaner to manage and track.
Delayed or not, though, to make things simpler from a legal, tax, and paperwork standpoint, consider incorporating your business when you’re first starting out.
If not, then consider incorporating before getting yourself into a last-minute situation, like in our next scenario.
Situation #2: Before signing legally binding contracts
The second situation for when to incorporate is before binding yourself to any legal contracts.
As a business owner, there are plenty of legally-binding documents you’ll need to sign. It’s better to sign those documents as your business rather than solely as you, so your company takes on the liability instead of you personally.
That being said, there are situations where you may need to personally guarantee a loan or contract, such as if you’re asking for a large loan or renting something expensive for your business.
In these situations, your personal assets may be on the line if your business is held liable should something go awry.
But generally speaking, signing legal contracts on behalf of your business will put the liability on your business rather than on you.
To draw a distinct line between you and your business when signing contracts, make sure your business name isn’t too similar or identical to your legal name.
Otherwise, things can get messy.
Writer Chaunie Brusie, for example, made this mistake when she used her personal name as the name for her LLC to make it easier when filling out paperwork.
Sadly, she found out three years later that this was the “wrong” thing to do since it confused the liability between Chaunie and her business, Chaunie Brusie.
The lesson here is:
There may be times when you’re asked to personally guarantee certain contracts, but incorporating your business -- and signing contracts as your business -- offers additional liability protection, so ideally, you want to do it before then.
And if liability protection doesn’t convince you it’s time to incorporate, maybe the next scenario will.
Situation #3: Once your income reaches a certain threshold
Another situation that signals it’s time to incorporate your business is when you reach a significant income threshold.
“Significant” as in when your earnings are large enough that it’d be risky if you didn’t protect them.
If you’re looking for a point of reference, 66% of small business owners earn less than $100,000 per year from their businesses, and the average small business owner’s salary is $68,959 at the time of writing.
Business lawyer, Keren de Zwart, recommends:
“There’s no hard and fast rule, but if your business is netting at least $60K in profits, that’s usually a good time to formalize into an LLC or corporation because the tax benefits can really start to be utilized then.
If you have high personal net worth and/or significant personal assets, it may make sense to form an entity earlier on to protect yourself.”
Accountant Greg O’Brien, on the other hand, says it may not be worthwhile to consider restructuring your business until you’re close to earning six figures.
Regardless of what your threshold number is, it makes sense to incorporate your business when you’re earning an amount that’s significant to you and your business.
Next up, we’ll cover our fourth situation for when to incorporate, which is when you hire an employee.
Situation #4: When you’re ready to hire an employee
Finally, it’s a good time to incorporate your business when hiring your first employee.
This offers you some legal protection if you somehow get yourself into a lawsuit with your employee, whether your employee sues you or your employee does something that gets you sued by someone else.
You don’t have to wait until you have a certain number of employees to incorporate, either.
73% of corporations and 81% of pass-through entities have less than 10 employees, so small teams are the norm these days.
Besides forming a different business entity, there are other ways to protect your business when hiring employees.
To start, familiarize yourself with the IRS’ rules for hiring and managing employees so you can understand your tax obligations and avoid potential lawsuits.
Adhering to your country’s and state’s labor laws can lower your chances of receiving fines or a lawsuit.
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Incorporate to protect your personal and business assets
Consider incorporating your businesses if you want:
- Extra liability protection when operating your business
- To potentially lower your tax bill
- To increase your chance of receiving business funding
- To sell or transfer your business in the future
- To project a more professional image to your customers
As for when you should incorporate, these four situations present an ideal time:
- When your business is just starting out
- When you sign legally binding contracts
- When your income reaches a certain level
- When you hire your first employee
So, are you ready to make the leap from side-hustle to official business? We’re standing behind you every step of the way.
By the way, if you don’t yet have a single platform to easily manage your online business, sign up for this 14-day no-obligation Podia trial. It’ll make your side-hustling less about hustling and more about streamlining your business.