One of the most common mistakes small business owners make is operating their business as a sole proprietorship. Not only does this create significant legal liability for you and your household, but can also increase payroll expenses. When you incorporate, whether as an LLC, C, or S-Corporation, your business becomes a separate legal entity, and protects you from most forms of liability. If your business, for example, was sued by a customer for a job that did not meet their expectations, only your business assets would be at risk. The customer could not sue you personally and come after your home, automobiles, cash, etc. Similarly, if your business had an unsecured credit line with a vendor and could no longer pay, the vendor can only come after your business assets. Provided you did not personally guarantee the credit line, your personal assets cannot be touched. This is reason alone to consider incorporating.
The other big reason to incorporate is tax treatment. When you are self-employed as a sole proprietor, you must pay self-employment tax, which is both the employer and employee side of social security and medicare taxes. It equates to about 15% of your business income, and this is in addition to federal and state income tax. For businesses with a single owner, an S-Corp is an ideal means of incorporating. In this scenario, you and your business still pay the same in payroll taxes – but there is one big difference: S-Corp owners are eligible for profit distributions. These are payouts, scheduled on a regular basis (yearly, quarterly, etc.) that are not subject to medicare, social security, or (in Rhode Island) TDI taxes. You only pay income tax on these distributions. There are limitations. You still must pay yourself a reasonable regular salary based on the work you do. For example, say you own a photography studio and perform much of the work yourself. If you set your salary as $20,000/yr and pay yourself $100,000/yr in distributions, that probably would not pass the IRS reasonableness test – a full-time photographer makes much more than $20,000/yr. If caught, the IRS would make you back pay the taxes you skipped out on plus a penalty. But as long as your salary is reasonable, you can avoid a substantial amount of tax as an S-Corporation. Consult your accountant for more details.
Quick Tip of the Week
Whether you sell products or services, the number of choices you offer the customer can have a significant impact on sales, and there is solid science to back this up. In a study of company retirement programs, researchers found that the more mutual fund choices that were offered to employees, the less likely they were to enroll in a plan at all. In an analysis of over 800,000 workers, when only two mutual funds were offered, 75% of workers participated in a retirement plan. When the number of funds offered grew to five, just 60% of workers enrolled.
In another study conducted at a supermarket, two displays were used to sell various types of jam. One version offered 6 options and one version offered 24 options. The difference was mind-blowing: only 3% of shoppers who approached the 24-choice display made a purchase. While an impressive 30% of shoppers purchased after approaching the much smaller 6-choice display.
Ultimately, researchers found that when faced with multiple choices, consumers often put pressure on themselves to make the right decision. The more options that are offered, the higher likelihood that a bad decision could be made – which is why in many cases they forgo the purchase altogether. This insight can be applied to almost anything you sell with options. If you offer service plans, for example, it may be wise to offer just 3 tiers (i.e. Good, Better, Best) instead of a large variety that could cause confusion and pressure the customer to make the right decision.