Common Question: “At what income level should I incorporate?”

One of the most frequent questions I receive from sole proprietors is, “At what level of income should I incorporate my business?” Looking at the internet or books, you often see benchmarks such as, “It is more profitable to incorporate once taxable income exceeds XX million yen.” It is true that from a purely tax perspective, such a line does exist. However, should the decision to incorporate really be made based on that alone? This is the reason I decided to write this article.

Why it looks “more advantageous to be a corporation” when looking only at taxes

From a tax standpoint, for sole proprietors, the progressive tax rates for income tax and inhabitant tax increase as income grows. On the other hand, for corporations, the corporate tax rate is relatively flat. Once income exceeds a certain level, there are phases where the corporation appears more advantageous based solely on the difference in tax rates. This is why the conversation about “incorporating once you exceed this amount” arises. However, this is a discussion that looks at taxes in isolation.

The often-overlooked impact of social insurance premiums

In practice, when considering incorporation, social insurance premiums must always be considered as part of the package. Once you become a corporation, as a general rule, it becomes necessary to enroll in social insurance for directors’ compensation. While sole proprietors pay National Health Insurance and National Pension, a corporation uses Health Insurance and Employees’ Pension, and the premium burden generally becomes larger. Furthermore, although social insurance premiums are “split half-and-half between the company and the individual,” in practical terms, the entire amount is a cost when viewed as a whole. Even if taxes decrease slightly, there are cases where net take-home pay actually decreases due to the increase in social insurance premiums. As a result, the income threshold at which incorporation should be considered rises significantly higher than when considering taxes alone.

Corporations have “fixed maintenance costs”

Furthermore, corporations incur maintenance costs. Fixed costs will arise, such as the per capita basis of corporate inhabitant tax, the effort of tax filing and tax accountant fees, and the costs of various procedures such as registration and social insurance. These are also factors that cannot be ignored when deciding whether to incorporate. Even if taxes become somewhat more favorable, it is necessary to carefully assess whether it is truly meaningful after subtracting these maintenance costs.

Cases where incorporation is still meaningful

So, is incorporation an “unprofitable choice”? That is certainly not the case. If you intend to continue the business over a long period, incorporation offers clear merits beyond taxes and costs. Examples include credibility with business partners and financial institutions, clear separation between the business and the individual, ease of business succession and recruitment, and designing for future scaling. These are values that cannot be measured solely by a short-term comparison of tax burdens.

The rationality of continuing as a sole proprietor

On the other hand, if you are only considering the perspective of taxes and costs, I believe that the choice to continue as a sole proprietor without forcing incorporation is also perfectly rational. Especially in cases where the business scale is stable and there is no strong intention for future expansion, or when assuming a freelance-style of working, the simplicity of being a sole proprietor is a significant advantage.

Summary: Think about incorporation by working backward from your “future vision”

Ultimately, the timing of incorporation is not something to be decided solely by “how much income” you have. It is necessary to make a judgment based on a perspective that includes taxes, social insurance premiums, maintenance costs, and above all, how long and in what form you want to continue that business. Rather than applying a simple standard like “incorporate once you exceed X amount,” we recommend thinking by working backward from the future vision of your business.