Should you incorporate as a contractor?

If you are a contractor, the first thing you need to do is decide if this is best for you. In most cases, it is. Why? Setting up a corporation or LLC offers many advantages and protections for contractors.

The first reason is liability protection. A corporation is a separate entity from its owner(s), and so provides a shield from lawsuits not available to sole proprietors. For example, if you are a plumbing contractor, you are on the job and you back your van or truck over someone on a sidewalk, there is a corporation to be sued. If you break a pipe and flood a house, your corporation’s insurance may cover it.  If someone injures himself after stumbling over your tools, it is better to be incorporated than not. But you cannot be negligent and expect total protection just because you are incorporated.

Incorporation offers credibility because many suppliers, vendors, and customers prefer to do business with a corporation or LLC. It also provides credibility with banks and government agencies. By establishing strict separation between business and personal funds, the accounting is cleaner. Also, since liability is limited to corporate assets, insurance companies can insure you at lower premiums due to lower risk.

As a sole proprietor, you assume all liability and your personal assets are at risk.

The advantage of remaining a sole proprietor is that you save on fees associated with setting up a corporation or LLC. If you do this, however, you lack insulation from personal liability. One lawsuit can drive you into personal bankruptcy and more than wipe out any savings from not incorporating.

If you choose to incorporate, you may find it to be a relatively simple process. You can hire an attorney, an accountant, a professional incorporation service, or do it yourself. If your situation is complicated by legal, family, estate, or other considerations, you probably should consult a lawyer or accountant. For example, you may need an operating agreement filed as part of an LLC that spells out profit distributions among LLC members.

Whether you choose to set up a corporation or LLC, the process is similar from state to state. The fees and requirements are available on each secretary of state’s website. Once you evaluate for yourself the risks and benefits of sole proprietorship against those of incorporation, you will likely find that incorporation is the best choice.