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benefits of incorporating

Page history last edited by PBworks 15 years, 8 months ago

 

 

 

Forming a corporation or LLC can be a big step towards your success and the success of your business. There are many benefits of forming a corporation or LLC that are not available to sole proprietors or partnerships:

 

**Protect your Personal Assets****

The primary reason many businesses form corporations is to protect their personal assets. Without setting up a legal entity for your business, like a corporation or LLC, your personal liability for business debt is unlimited. This means that should your business experience severe financial difficulties, creditors can take away your personal property such as your home, retirement savings, or any other asset you or your spouse own. Forming a corporation or LLC for your business can protect your personal assets.

 

Save Money on Taxes

If you are operating as a sole proprietor, you will be required to pay self-employment tax on your profit, currently at 15.3%. If you set up a corporation for your business, only the salary you pay yourself is subject to self employment tax. With an S-Corporation, the remainder of the profit is not subject to self employment tax, saving you money. Another tax benefit of forming a corporation is that select medical and childcare costs may be deductible, which cannot be deducted as a sole proprietor.

 

Reduce your Chance of Tax Audit

Statistics show that a business operating as a sole proprietor (Schedule C) is more likely to be audited by the Internal Revenue Service than a business operating as a corporation.

 

Look and Feel Professional

Putting "Inc." or "LLC" after your business name can give you credibility with your customers. Corporations, LLCs, and other legal entities can be a sign of credibility, professionalism, and trust.

 

Legal benefits

 

* Protection of personal assets. Safeguarding personal assets against the claims of creditors and lawsuits. Sole proprietors and general partners in a partnership are personally and jointly responsible for all the liabilities of a business such as loans, accounts payable, and legal judgements. In a corporation, however, stockholders, directors and officers typically are not liable for their company's debts and obligations. They are limited in liability to the amount they have invested in the corporation (eg: If $100 in stock was purchased, no more than $100 can be lost). Corporations and Limited Liability Companies (LLCs) may also hold personal assets like houses, cars or boats. If one is personally involved in a lawsuit or bankruptcy, these assets may be protected. A creditor of the owner of a corporation or LLC cannot seize the assets of the company, however, they can seize their ownership shares in the corporation, as that is considered a personal asset.

* Transferable ownership. Ownership in a corporation or LLC is easily transferable to others, either in whole or in part. Some states' laws are particularly attractive to this end. For example, with a Delaware Corporation, the transfer of ownership in a corporation is not required to be filed or recorded.

* Retirement funds. Retirement funds and qualified retirement plans (like 401ks) may be set up more easily with a corporation. Corporations can also fully deduct the cost of paying its owner's health insurance.

* Taxation. In the United States, corporations are taxed at a lower rate than individuals. Also, they can own shares in other corporations and receive corporate dividends 80% tax-free. There are no limits on the amount of losses a corporation may carry forward to subsequent tax years. A sole proprietorship, on the other hand, cannot claim a capital loss greater than $3,000 unless the owner has offsetting capital gains.

* Raising funds through sale of stock. Capital from investors can be raised for corporations easily through the sale of stock.

* Durability. A corporation is capable of continuing indefinitely. Its existence is not affected by the death of shareholders, directors, or officers of the corporation.

* Credit rating. Regardless of an owner's personal credit scores, corporations acquire their own credit rating, and build a separate credit history by applying for and using corporate credit.

 

 

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.

 

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.

 

 

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.

 

 

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.

 

 

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 2006. 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 2006. If Willie operates as a sole proprietorship, he'll owe self-employment tax on the full $60,000 ($60,000 x 15.3% = $9,180).

 

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 15.3% = $6,120). Thus, incorporating his business would save Willie $3,060 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!

 

**Further resources: mycorporation.com

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