Legal entity or individual entrepreneur

1. Become a legal entity or continue to be an individual entrepreneur?

When a business as an individual entrepreneur (Kojin Jigyonushi) expands, the option of constituting a legal entity (Hojin) can be considered. This article analyzes the advantages and disadvantages of continuing to be an individual entrepreneur and setting up a legal entity. Legal entity includes not only companies (Kaisha), but other types of legal entity as a general incorporated association (Ippan Shadan Hojin).

2. Advantages of being a legal entity

(1) Tax advantages

1 Income tax and legal entity tax

One of the advantages of setting up a legal entity is to save tax in some conditions. The income tax rate paid by individual entrepreneurs ranges from 5% to 45%, depending on their income. The higher the income, the higher the income tax rate. On the other hand, the legal entity tax rate is set at 15% for the annual income portion of less than 8 million yen and at a fixed rate of 23.2% for the upper part. In other words, when the annual income exceeds 8 million yen, the rate remains constant.

Therefore, from the point of view of income tax, the constitution of a legal entity is more beneficial from the point of view of tax savings when the amount of income is greater. In general, it is said that the amount of tax is almost the same from an annual income of 8 million yen, and that the legal entity tax is lower than income tax when the income exceeds 8 million yen. However, there are many other ways to save taxes by setting up a legal entity as I will explain later, and in some cases, even when the income exceeds 5 million yen, there may be tax advantages when setting up a company. In any case, the calculation of whether or not you can save taxes is complex and must be decided by consulting a tax advisor.

2 Income tax deductions for employees

Another advantage of a legal entity is the possibility of applying income tax deductions for employees. Individual entrepreneurs are taxed on all their income, while employees are subject to income tax for their remuneration minus a certain amount. This means that, instead of calculating your income as an individual entrepreneur, you pay less income tax by receiving it as the salary of the president of a legal entity.

3 Payment of salaries to family members

When a legal entity is formed, it is said that it is easier to distribute income within the family and reduce the amount of taxes paid by having family members as directors of the legal entity, compared to an individual entrepreneur.

4 Other advantages over tax

There are other advantages over tax for legal entity.

An employee's retirement payment cannot be charged as an expense by an individual entrepreneur, but by a legal entity.

If sales exceed 10 million yen, both the individual entrepreneur and the legal entity are subject to consumption tax from the following two years. However, if you constitute a legal entity in the year in which you must pay the consumption tax as an individual entrepreneur, you can postpone the obligation to pay the consumption tax for another two years.

(2) Credibility

Another advantage of making a legal entity is that it increases trust.

Unlike individual entrepreneurs, legal entities must register and make public various data, such as the commercial name, the address of the registered office, the amount of capital and the name and address of the representative administrator.

In this way, their information is made public in accordance with the rules of the laws, it can be said that legal entities are much more likely to gain social trust than individual entrepreneurs.

Greater credit means greater business opportunities and easier access to financial institutions' financing.

3. Disadvantages of making a legal entity

(1) Increase in administrative work

Legal entities have a higher burden of preparing tax documents than individual entrepreneurs. Accounting and other administrative tasks of accounts are more complex for legal entities than for individual entrepreneurs, and the paperwork for this is greater.

(2) Social security membership

Legal entities need to affiliate to social insurance for members. This procedure is needed to join social security.

Even if there is only one employee, legal entities must be covered by the social insurance. And since the legal entity and the worker bear half of the social security contributions, the social security contributions of the legal entity increase as the number of workers increases.

However, this can be considered a benefit in the opposite direction. Individual entrepreneurs do not have the right to join social security. Social insurances offer more generous payments in terms of pensions than National Health Insurance, which is covered by individual entrepreneurs.

(3) Costs and tasks to be founded

Naturally, the first step is to establish the establishment. This is expensive, but not expensive. In the establishment phase, many documents also have to be prepared. It would be better to ask the lawyer or other specialists for those foundation tasks.

4. Summary

If you have been operating successfully as an individual entrepreneur or have started hiring employees, you may not be sure whether to continue your business as a sole proprietor or become a legal entity. As explained in this article, moving from individual entrepreneur to legal entity changes many aspects of your business. What is important for the entrepreneur and what is necessary varies according to the person and business. It is important to make the right decision on whether to set up a legal entity and when to do so. If necessary, it is advisable to consult a lawyer, tax advisor or other expert. If you have made the decision to create a legal entity, it is also a good idea to ask a specialist to help you with the foundation process.