More Small Business Owners are Incorporating… Should You?

Date posted: March 7, 2017

self-employed

By Matt Baker

The U.S. Bureau of Labor Statistics (BLS) is a remarkable trove of data. The BLS tracks everything from wages by occupation to the national unemployment rate to the consumer price index. The information is publicly available and credible which is a surprisingly rare combination. The reports are useful to business owners of all sizes and professions. For example, if you’re planning to offer a new product or service for consumers, the Consumer Expenditure Survey itemizes buying habits of Americans by category so that you can assess willingness to pay.

However, the BLS has relatively little data on self-employed individuals. Based on my experience serving self-employed individuals and the businesses they create, I believe this is the segment of the U.S. workforce most in flux and least understood by traditional economic measures.

Case in point: The BLS is a 2,500-person organization that’s been around since 1884. It’s slow to change and its measures aren’t built for careers that didn’t exist 10-20 years ago (such as email marketers and mobile app developers). Leveraging data from the Current Population Survey (a monthly survey of 60,000 households conducted by the U.S. Census Bureau), the BLS reports on the rate of self-employment and incorporation status.

Many Self-Employed Individuals Have Incorporated Businesses
In the most recent report (March 2016), the BLS found that 37% of self-employed individuals have incorporated businesses. The remaining 63% have sole proprietorships, partnerships, or other structures.

Considering BLS data is collected through a survey designed in the 1940s, it’s not a  great tool for understanding the new economy. For a second opinion, the data from online accounting software platforms represent a large collection of self-employed professionals.

FreshBooks sampled data from 10,000 self-employed individuals making $20,000 or more annually (income minimum excludes part-timers) and found 44% have incorporated businesses. That’s nearly 20% higher. But why? I believe there are two primary reasons that highlight leading indicators for the economy at large:

1. Business Owners Who Use Accounting Software Have More Time to Manage Their Businesses

Business owners who purchase accounting software (as opposed to a collection of spreadsheets and notebooks) are still in the minority among the 55 million independent workers in the U.S. but consumption is growing rapidly.

The owners who use accounting software save time on various administrative tasks which can be applied to researching the benefits and costs of incorporation. The knowledge boon is leading to a higher rate of incorporation.

2. Self-Employment is an Increasingly “Legit” Choice

Many of the individuals today who are choosing self-employment over traditional careers are doing so by choice not necessity and collectively represent a new economic movement.

In particular, individuals who have had successful corporate careers before making the switch to self-employment are more established and want to sort out the question of business structure from the get-go, which is also leading to a higher rate of incorporation.

3. The Rate of Incorporation Varies by Profession

In both data sets, the rate of incorporation varies by profession. At one extreme, over 70% of the “non-profit” business owners have incorporated businesses.

As you might expect, this is driven by regulation and benefits. A non-profit organization must be incorporated to get 501(c)(3) status in the US and lay claim to tax exemption and state and federal grants.

At the other extreme, less than 30% of business owners in creative professions (such as designers, writers, and photographers) have incorporated businesses. Call it stereotyping but I believe this is driven by a lack of interest and comfort among creative professionals to tackle the question of incorporation. Choosing to incorporate a business involves more formalities and more paperwork which is something the vast majority of creative professionals I know want to avoid.

Several professions are split down the middle. Just about 50% of self-employed individuals in Management, Business, and Financial occupations have incorporated businesses.

4. 50% of Self-Employed Individuals Will Choose to Incorporate

By 2020, I believe rate of incorporation among self-employed individuals will grow to 50%.

In addition to increased adoption of accounting software and more self-employment by choice (which will increase the BLS rate of incorporation from 37% to 44% over time), there is more online education available today than ever before to support the question of business structure. This makes it much easier to grapple with a complex and nuanced topic in which potential benefits touch on limiting personal liability, implementing strategies to reduce tax rate, and tapping into additional sources of capital.

Apart from a systemic shock such as a significant decrease in the business tax rate for corporations alone, many other factors will create a natural ceiling for the rate of incorporation. For many, a corporation will simply be too much work or too much maintenance cost to justify the benefits. In other cases, choosing to incorporate can create a conflict of interest. For example, legal professionals tend to prefer partnerships due to former state laws concerning professional conduct.

While incorporation is not the right structure for any business, it’s fair to assume the rate of incorporation will increase as many self-employed individuals who could benefit from incorporating gain access to relevant online education. This increased rate of incorporation will ultimately produce a stronger self-employed economy.

Matt Baker is VP Strategic Planning at FreshBooks, a cloud accounting software solution for small business owners and self-employed professionals. Matt focuses on corporate strategy, long-term planning, market insights, and public relations. Prior to FreshBooks, Matt was an Engagement Manager at McKinsey & Company and a Senior Strategist at Google, Inc.

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