The A to Z guide how to incorporate your side hustle
Opening an e-commerce store is an exciting way to start a side hustle. When you launch it, it’s only natural to hope that one day it will grow into big business.
However, such aspirations can also raise a few uncomfortable legal questions, such as:
- When should you incorporate your side business?
- What legal responsibilities will you have to deal with?
- Which legal form should you choose?
- How to set it up and how much will it cost?
- How to handle taxes and administration?
If you can relate to these questions, this article was made for you. For now, you can just sit back and relax. When it comes to your business, dealing with legal matters is much easier than it sounds.
Everything unfamiliar in life seems like a dark, spooky forest at first. However, that impression changes once you get to know things better.
Business regulations are no different. This guide will show you how to incorporate your side hustle, what common legal structures are available, and how to start your business on the right foot.
* This guide is for informational purposes only and does not constitute professional legal advice. Please consult independent legal advice experts for information specific to your country and circumstances.
What is Business Incorporation?
By definition, business incorporation usually refers to establishing a corporation, but in this guide, we’ll refer to it as the process of establishing any business structure recognized under the law.
The benefits of incorporating vary depending on the type of legal form of the company. Generally, it helps to save more money for business expenses, limits shareholders’ and owners’ liability, offers tax benefits and enables your business to exist and grow in the long run.
Of course, it also comes with increased responsibility, bureaucracy and costs. For example, in the United States, founders have to pay between $25 and $1000 ( depending on the state) to incorporate a firm.
Whether your side gig is just for fun or a gateway to a better life, making it legal is one of the smartest moves you can make as an entrepreneur.
Let’s take a look.
The humble beginnings
Many aspiring entrepreneurs worry about the first step when it comes to starting a side hustle. Things like how to set up the company, which company type to choose, how to pay taxes and how to make sure you don’t make some crucial mistake in the very beginning.
Yes, it’s complicated at first but it gets easier.
Besides, there are many online communities to guide you. Sites like Reddit, Indie Hackers, Start Up Nation, Small Business Forums or BizWarriors are a buzz with people sharing their knowledge, experiences and advice.
At the beginning, you may even choose not to register your side hustle.
Every country has different laws when it comes to personal income, but the general advice is to register your for-profit activities right away. Even so, there’s a chance that you won’t start making piles of money immediately. The truth is that if you make $100 once in a while, no one will bat an eye. It would be a waste of the taxpayers’ money to come after you for every penny you make. Also, you can always declare it as an income got from your hobby, as long as you don’t make any significant profits on a regular basis.
However, if you’re serious about your side hustle and don’t want to call it a hobby, you’ll be interested to know specific benefits that come with incorporation.
When does your hobby become a business?
The first thing you should consider when starting a side hustle is your commitment. Are you doing it for the money or would you rather keep it as a hobby?
Most national tax systems have a set of rules that mark a distinction between the two. Generally speaking, it goes like this: if you’re making money and your end goal is to make money – you’re a business, but if you run a hobby, then it is…just a hobby. Perhaps it’s something you’ve set up for the learning purposes, you may even make a few bucks here and there, but that’s all there is to it.
The critical difference here is how much money you make. For instance, if you just set up an online store to learn the ins and outs of e-commerce, and you’re not profiting from it, it can still pass as a hobby. However, if you turn to profit and receive sustainable income for a period of time, it’s a business.
But there’s another important factor to consider
It’s important to take yourself seriously from the beginning.
If your side hustle is meant to earn money professionally, you should treat things seriously from the start – act like a business. It will ease your mind, it will liberate you, and you will have the right mindset for success. It’s contagious. If you take your hustle for real, other people, clients, and stakeholders will do the same.
Even more, there are great benefits to being a business
If you start as a hobby, you aren’t entitled to any tax deductions that are granted for businesses. You can’t deduct business expenses from your income, and that can be a big deal, especially when you’re starting out.
If you incorporate your brand, you’ll be able to deduct all your business-related expenses as a money-making entity, along with some other advantages. The ability to report all your business expenses lowers your taxable income, which means a smaller tax bill and more money for your business development.
Keep these considerations in mind when you set up and don’t be afraid to call yourself a business as soon as it picks up. It will help you maintain focus and give you more freedom to operate.
If you’re unsure that similar rules apply in your country, be sure to check with your local advisors who have more experience and competence in this subject.
Advantages and disadvantages of incorporating a business
Many first-time entrepreneurs who have side income in addition to their full-time job are hesitant to legitimize their activity. When your side hustle is taking off, consider the following arguments for and against incorporation.
- It’s an excellent way to protect your assets. When you establish a corporation or a limited liability company (LLC), you create a separate legal entity which is not connected to the private property. In case you go bankrupt, you won’t lose any of your savings.
- You can transfer the ownership anytime. When your business takes off, you can sell or hand it over without much trouble.
- You can make use of tax deductions. Most jurisdictions provide tax benefits for businesses and entrepreneurs.
- It lets you take more business risks. Since incorporation (in most cases) separates your assets from business assets, you will be free to take additional risks to facilitate growth.
- It opens you more options for funding. You can try to attract equity investors.
- It gives your business more credibility. It’s a clear statement that you’re a serious entrepreneur. You’ll attract better employees, higher-level clients and partners.
The main counterarguments against incorporating your side hustle are:
- Maintaining business administration and dealing with bureaucracy. Yes, there can be much paperwork.
- You’ll have to pay fees and taxes. As Benjamin Franklin used to say “nothing can be said to be certain, except for death and taxes.” In this case, there will be more of the latter – establishing fees, VAT, income taxes and other necessities.
- Liability protection isn’t guaranteed. If there are claims made against your business or you break the law, you can still be liable if found guilty.
- Unless you’re good at bookkeeping, you’ll have to hire an accountant or advisor to help you. At a glance, it may seem like an extra cost, but it will help you to save truckloads of money in the long run.
Now that you’re aware of the pros and cons of incorporating a business, let’s review the legal options for your side hustle.
Legal options for your business
It’s important to understand at least the basic law of business organization. It will help you make the right business decisions. Four common business models are found in most countries. Their titles may differ, but the core principles remain the same.
A sole proprietorship is the easiest and most popular business form, at least in the United States.
It is a simple form of business which offers no legal distinction between the company and its founder. It does not create a separate legal person, so your business and personal assets are treated as one. The same goes for business taxes – they are filled in a personal tax return (except VAT).
Despite the personal risk, it’s the easiest structure to arrange and manage. All you need to do is go to your local jurisdiction, get a license, register a business name and you’re all set. You can hire employees and independent contractors on demand and usually there’s no limit to the number of people you can employ.
Sole proprietorship is the most common structure for e-commerce merchants – it’s a perfect model for businesses that have a low risk of liability.
However, when your business ownership grows to more than one person, it no longer can be a sole proprietorship. When needed, it can be upgraded to another business form.
Key takeaways: Sole proprietorship
- Easy to launch and run.
- Low set up costs.
- Tax filing is done together with your individual income tax return.
- You are in full control of all business decisions and profits.
- You risk personal assets in case of debt or lawsuit against your company.
- Officially, your company is not a separate legal entity.
- If you start earning too much, you may hit a higher tax bracket.
A partnership is a small business structure identical to sole proprietorship, except it enables to have two or more owners.
Each co-owner contributes to the business with their resources, whether it’s equity, labor, skills or property. It increases a company’s chance of success, as few individuals chip into the common pool of companies competencies and assets.
The partnership revolves around an agreement which states that the business is divided among the co-owners. The ownership doesn’t have to be divided equally. One or several individuals can have the most significant percentage of the ownership, while other partners’ privileges can be limited.
Partnerships are also comfortable and cheap to register and manage. The responsibilities and profits are shared according to the partnership agreement and like in sole proprietorship, no separate legal body is created. Thus, every partner is responsible for reporting taxes in their personal income statement.
The key to a successful partnership is a well-drawn agreement. There’s always a chance that circumstances can change, thus influencing the entire business, so make sure that you have a legal advisor helping you to write a solid partnership agreement.
A decent partnership agreement must include:
- Names of all partners.
- A procedure of how new partners are included.
- Description of your business.
- Each partners’ level of liability and ownership share.
- A description of what happens if the partnership is dissolved.
Another key element for a successful partnership is selecting the right partner(s). Not every person is a good business companion. Hence, you should choose carefully with who you want to share debts, obligations, and responsibility for the business.
You don’t need to look far for inspiring business partnerships in recent history. Bill Gates and Paul Allen partnered to found Microsoft. Steve Jobs and Steve Wozniak were the first people behind Apple. Brothers-in-law William Procter and James Gamble partnered together to launch a business that today is known as P&G. Larry Page and Sergey Brin established Google together.
There are many more fantastic partnership stories, but if you want to make one as well, find a reliable partner first.
Partnership: Key takeaways
- Easy, quick and cheap to set up.
- Allows for a division of ownership, work, liability, and profits.
- Doesn’t require you to pay taxes separately (except VAT).
- Has a joint pool of resources.
- Simple to manage.
- Not a separate legal entity.
- Everything is jointly owned.
- Every owner is jointly liable.
- Risk of losing personal assets.
Limited Liability Company (LLC)
LLC’s have different qualities across various jurisdictions, but typically they are hybrid business structures – a middle ground between partnership and corporation.
An LLC is easier to manage than a corporation, and it also provides some protection for the owners’ property. Also, it needs less bureaucracy and has fewer profit sharing incentives. Despite that, it’s possible that LLC profits will be subjected to self-employment taxes.
LLC’s members do not pay taxes on profits directly. In most cases, the LLC doesn’t oblige them to file taxes as a separate entity. However, often they do have to submit extra forms for state taxes. Often, that includes payroll tax, too.
All in all, starting an LLC is more complicated than forming a partnership but is a more flexible business form than a corporation. The key advantage of LLC is that it limits the liability of its owners and managers. Yet, the regulations surrounding LLC are more complex. Therefore, the business will likely need to employ a good lawyer or an experienced accountant.
While partnerships and sole proprietorships are great for smaller businesses, an LLC is a great option when your business grows and starts dealing with more customers, partners and larger sums of money.
Key takeaways: LLC
- Limited liability.
- Relatively easy to create and administer.
- Flexible tax structure.
- Less paperwork than in corporations.
- Easy to transfer ownership.
- Higher licensing and filing fees.
- Additional tax forms.
- Profits may be subject to the self-employment taxes.
- More paperwork than in sole proprietorship or partnership.
A corporation is a legal entity separate from an individual. It’s owned by one or more shareholders and managed by a board of directors. In some cases, it can be just one or two people.
A corporation means that its owners are free from personal liability. In other words, the owners don’t risk losing private property and assets if things go wrong. For example, if your online shop ran out of money and ended up in debt, shareholders are not obliged to pay the difference.
The incorporation process is more complicated than in the previous options, but it also offers more potential benefits for online businesses.
Every country has different regulations for corporations, but the general notion is that you’ll need to file taxes separately, and abide all the rules and regulations that apply to your industry.
Therefore, having a lawyer or a publicly certified accountant is a necessity, as they will help you set it up in a way that is the most beneficial.
Other advantages of corporations are that it’s simple to transfer ownership – you can sell shares to raise capital and even sell stocks to the public (when you get big enough). The most common disadvantages are that corporations are difficult to form and maintain. If a corporate administration is not maintained correctly, you risk huge fines and can even lose the protection of personal property.
The tax situation is different, too. Most of the time, you can pay a smaller percentage of taxes, but in some cases, you may get taxed twice – on corporation profits and personal income tax.
Forming a corporation is generally the best option when there are multiple owners with large investments.
Alternatively, consider opening it only when your business is big enough, and you want to raise additional capital via shares or stocks.
Key takeaways: Corporation
- Ability to benefit from tax advantages.
- Limited personal liability.
- It’s a separate legal entity.
- It makes your business as credible as it can get.
- Easy to transfer ownership and raise funds.
- Heavy regulations.
- Required extensive record keeping.
- Expensive to form.
Choosing the right business form for your situation is an essential step. Most rules and business forms differ worldwide, so make sure to check in with a local legal advisor before you make a move.
Where should you incorporate your business?
If your business runs online and you have no need for a physical location or property, a natural question arises: “Do I have to incorporate my business in your own country?”
The answer is simple – no. Offshoring lets you establish a company whenever it’s most convenient.
What is offshoring?
Offshoring lets you establish a residency in a low or no tax jurisdiction and can significantly reduce your costs. For instance, if you establish your online business in Singapore, you will settle your accounts, business and business taxes there.
Some benefits of offshoring are:
- Retaining higher profits.
- Potential tax advantages.
- Additional liability protection.
- Economies of scale.
Despite that, offshoring can also pose certain disadvantages:
- Make sure that you comply with all your country’s laws (especially if you’re from the United States).
- There’s a certain risk with finding a trustworthy partner to help you set it up.
- Specific risks apply to certain jurisdictions only.
- It can cost a fortune to set up.
Should you incorporate in your home country or offshore?
The general answer is annoying and probably not what you’d like to read. It depends on your circumstances.
If you don’t feel like paying your share of taxes at home, you are free to find a tax haven. It can save you much money.
However, if you’re just starting out, don’t overthink and consider your home country a good starting point. There’s no need for extra hassle just yet.
Where to incorporate your business if you’re a digital nomad?
If you’re always on the move, your primary income source is the internet, and you don’t stay in one location for long, you probably call yourself a digital nomad.
As with every online business, most digital nomads prefer to incorporate their business in a country which makes it easy to manage, offer excellent benefits and offer less paperwork.
However, many other people strongly advocate offshoring, as it is beneficial for their company. If you’re interested in it, here’s the list of the best countries for relocation according to Incorporations.io.
Just remember, often the weakest link in this offshore setup for digital nomads is the bank where you have your account opened up. It is possible that their policies require you to be present in the local branch in case some problems aries. For a traveling digital nomad with a bank account in Thailand, who’s visiting Hungary for example, there requirements can become an issue.
Whichever option you prefer, you should always weigh your situation by consulting a legal advisor. Go for it, but only when you know all the risks you’re taking.
Conclusion: Which business formula is the best for me?
There is no general answer that every business can follow. Most online retailers set up their stores under sole proprietorship or partnership and only incorporate their business when the stakes grow higher, or there’s a good opportunity to sell it for good money.
It’s safe to say most online businesses don’t need to go through all the hassles of incorporation at the very beginning. However, if you’re a healthy, growing business with a bright future ahead, then there’s no time to waste, and you should start your incorporation right away!
9 takeaways to check when incorporating your side hustle:
- Consider whether your side hustle is business or just a hobby.
- Weigh the advantages and disadvantages of incorporation.
- Check with a local legal advisor if there are specific rules you must have in mind before incorporating.
- Do you need a partner or investor for your venture? If so, look for one.
- Decide if you want to incorporate your business in your home country or offshore.
- Look for an accountant or accounting agency which could help you with business administration. It will help you to save loads of precious time.
- Based on your incorporation location and operation scale, choose the most appropriate business form (Sole proprietorship, partnership, LLC, corporation or other).
- Fill all the required documents, contracts, forms and submit your registration.
- Obtain your business registration, and you’re good to go!