For the small business owner, the question of incorporating is a pointed one. A large percentage of small companies are run as sole proprietorships for a variety of reasons. At some point, though, the idea of incorporation comes up, and there are some valid reasons to go through the effort.
No one likes to pay taxes, even if they support the services that those taxes provide. If you own your business you have probably already found out that you must pay more taxes on your income than you ever did when you were employed by someone else. Why is this?
When you are an employee, your employer paid half of your Social Security and Medicare taxes. Now that you own the company, you must pay both halves: yours and the business half. That comes out to a fairly significant percentage of your income.
S-Corps Can Save You a Lot
There are number of ways to incorporate, but one that is particularly popular with small business owners is the S-Corp.
First, you will save if you don’t make a profit in the beginning. Any losses the company suffers are deductible from your taxes. While you won’t recoup the entire amount, it can really add up.
Second, a S-Corp allows the owner to pay out part of the company’s profits as corporate distribution. This dramatically reduces the amount charged for Social Security and Medicare since a distribution isn’t the same as a salary. Part of the profits will remain as regular salary, but you can cut your taxes in half or more with such an arrangement.
Protect Your Assets
Did you know that if you run your business as a sole proprietor or contractor, everything you own can be tapped in a financial crisis? Many business owners don’t know this until a problem occurs and suddenly their home, vehicle, or savings account is on the line. Even if you carry insurance for your small business, any assets you have are in jeopardy if you don’t incorporate.
Incorporation puts a layer of protection between your personal assets and your business assets. If you are ever sued as a business, none of your personal assets can be touched if you incorporate properly. Of course, this means that you have to be very careful to follow appropriate procedures when you pay yourself out of your business funds, when you deposit payments, and when you keep your books, but it is well worth the extra effort to provide such protection.
Incorporate Inexpensively
You don’t actually need an attorney to incorporate under most circumstances. How much you will spend will depend upon the local laws. Each state will have specific guidelines for you to follow, and you can even opt to do the whole job on your own. Online services can help you through the process, at a cost, and in a couple of days you will be legally incorporated.
To find out what is required in your state, contact the office of the Secretary of State (SOS). You can usually find all the forms you need and have your questions answered online at the SOS website.
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When I incorporated a few years ago, I used an online service and the cost was $350. The cost differs by state and type of corporation, but I thought it was worth the money. They have a way to hook you in for ongoing subscription service where they want to be the location for biz correspondence, etc and charge a fee for it. I opted out, but it wasn’t easy or convenient to figure out how to do that.
There are a couple of points I would like to make, and it may seem a bit trivial to some, but it’s just to clarify some things.
Firstly, in the case of a tax loss in the early years, the deduction that is allowed to be carried over to the 1040 is limited to the basis the shareholder(s) has in the company. So if the tax loss is $10,000 but the shareholder(s) only put in $5,000, then only the $5,000 is allowable as a loss to be carried to the Schedule E on the individual return.
And, just to clarify the lawsuit issue, being incorporated does not provide a true “iron veil” as many believe. It generally does, but if something should happen during an activity that was not within the scope of the business, then the individual can be held personally liable for damages.
Again, this may seem like nit-picking, but that isn’t my intention. Just trying to clarify some points that in my experience get a little hazy.
Regarding the profits (taxwise), they are intended to be distributed at the end of the year, so no distribution of tax profit will be taxable to the shareholder unless, again, it is in excess of basis in the company.
I’m still debating on whether to choose an S-Corp or an LLC. I’m talking to a few different bloggers to see how they did it.
The tax benefits are exactly the same when it comes to deciding on LLC vs. S-Corp. An LLC can still elect to be taxed on an 1120-@ by filling out the same Form 2553 – Election by a small business corporation. The real differences are mostly legal issues as far as protection (hence the name Limited liability company) if that helps you any.
Creating my s-corp has saved me literally thousands of dollars for the reasons mentioned above.
In addition, a few other benefits I’ve been able to take advantage of through my s-corp:
A retirement plan: Using a SEP-IRA, my s-corp contributes to my retirement account; these contributions are a business expense, and thus lower the net income of my s-corp. The s-corp can contribute up to 25% of the employee’s gross salary.
Health insurance: My s-corp pays 100% of my health insurance premiums. At around $1,100 per month for a family of 4, this is no small thing. The premiums are a business expense, and again lower the s-corp’s net income.
Other expenses: My s-corp pays for my cellphone and high-speed internet, since I typically work from home. Other expenses (laptop, etc.) can be deducted as well. Again, these are all deductible, and lower the s-corp’s net income.
The retirement and healthcare insurance are employee benefits offered through the s-corp. Since I’m the only employee, that works great, but if I hired other employees–which I don’t need to do, since I can hire contractors instead–the other employees would also be included in those benefits.
Again, this is excellent advice which has literally saved me thousand of dollars.
We have an S-corp. and my accountant adds the insurance premium to our profit. Is she doing this wrong? Or does it pass back to you too.