Tax Advantages in Owning Your Business

Corporations are afforded a series of tax benefits and advantages by the IRS that are not available to sole proprietorships and other forms of small business. The following tax benefits may or may not apply to you. In particular, some of the benefits described apply only to C-Corporations, whereas others apply only to S-Corporations. Consult your tax professional for details and for advice as to which entity is appropriate for your particular needs.

Income Shifting

The ability to divide income between the corporation and its shareholders in a manner that lowers overall taxes is referred to as Income Shifting. This practice is by far one of the greatest benefits of incorporating a business. Profitable small businesses with shareholders in higher tax brackets stand to benefit the most from the practice of income shifting. However, paying out ALL profits may not be viable for a corporation who plans to retain earnings to expand its product line or increase its advertising budget next year. Fortunately, profits retained within a corporation are taxed at the initial tax rate of only 15%. It is this ability to retain earnings within the business, without imputing tax liability to shareholders, that provides an invaluable tax advantage to growing corporations that is not available to S-Corporations and unincorporated business entities.
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Fringe Benefits

While startup businesses in this unpredictable economy may be less eager to offer fringe benefits to employees, corporations are afforded favorable treatment over non-corporate entities in the area of fringe deductions. For example, corporate retirement and corporate medical plans can offer greater contribution limits and more flexibility than unincorporated entities. Thus, once your company is thriving, favorable tax treatment for fringe benefits can be a compelling reason to incorporate your business. For example, did you know that sole proprietorships, partnerships and limited liability company members can only deduct about 30% of medical insurance premiums? Corporations, on the other hand, can deduct 100% of insurance premiums with the proper insurance plan. In addition, corporations have the flexibility to adopt a medical reimbursement plan and allow deductions for medical expenses not covered by insurance policies.
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Business Losses

In a corporation, there are no limits or restrictions on the amount of capital or operating losses that a corporation may carry back or forward to subsequent tax years. Unincorporated entities, however, are subject to more stringent rules regarding corporate losses. For example, an individual owning a sole proprietorship cannot claim a capital loss greater than $3,000 unless he or she has offsetting capital gains.

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Dividends From Other Corporations

Where a corporation is cash-heavy and shareholders do not desire to withdraw the cash assets, the "dividends received" exclusion will serve as a great benefit of incorporating. In a nutshell, a corporation can receive dividends from stock it owns in another unrelated corporation 70% tax free. In other words, where an individual may be required to pay taxes on ALL of a $10,000 corporate stock dividend, a corporation that falls within the "dividends received" exclusion is taxed on only $3000. This gets tricky.so please consult your tax professional before implementing this strategy.
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Leasing Assets to your corporation

Leasing your personally owned property (real estate, automobile, or even a domain name) to a corporation may provide tax savings to many individuals. Please note, however, that the IRS will often scrutinize this type of leasing arrangement. Therefore, the lease terms must be fair to both parties in the transaction (to you and to your corporation). This benefit of incorporating is rather similar to the "Income Shifting" discussed above.
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Self-Employment Tax Savings

In an S-Corporation, however, only earnings actually paid out to an owner as compensation for services are subject to payroll taxes. Any money left in the business for reinvestment or distributed to the shareholder as a dividend is not subject to payroll taxes...and not subject to self-employment tax.

Let's review an example: "Willie," a struggling country singer known for his exemplary tax payment history, operates as an unincorporated, sole proprietorship. Willie and his band earn a net income (gross income less expenses) of $60,000 during 2002. During the course of the year, Willie withdraws $40,000 as his personal salary leaving the remaining $20,000 in the business to purchase amplifiers and whiskey in the year 2003. If Willie operates as a sole proprietorship, he'll owe self-employment tax on the full $60,000 ($60,000 x 12.4% = $7,440).

However, if Willie forms a corporation, elects S-corporation status, and withdraws the same $40,000 as compensation for his services, he would only owe self-employment taxes on the $40,000 in salary ($40,000 x 12.4% = $4,960). Thus, incorporating his business would save Willie $2,480 in payroll/self-employment taxes.

To take advantage of all potential tax benefits, and if your accountant agrees, incorporate your business online today. Come tax time next year, you'll be glad you did!
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