Have you been thinking about incorporating your small business
or self-employment activity? The advantages are many!
For starters, you'll be protecting yourself and your family from
the possibility of a business ending lawsuit. Forming a
corporation is Step One on the path known as "Asset Protection"
-- you are moving from the world of unlimited liability to the
world of limited liability.
(NOTE: For further insight into the legal advantages of
incorporating, check out the article: "It Can Happen To You: Why
Any Sole Proprietorship Is A Risky Business" at
http://www.YouSaveOnTaxes.com/happen-to-you.html)
From a tax standpoint, there are both advantages and
disadvantages to incorporating. Yes, forming a corporation can
either reduce your taxes or increase your taxes, depending on
what type of corporation you create.
There are two main types of corporations: "C" Corporations and
"S" Corporations -- and which type you choose can make all the
difference in the world of taxes.
NOTE: The question of "C" Corp vs. "S" Corp has no effect on the
asset protection provided by your corporation. This is a tax
issue, not a legal issue.
A "C" Corporation can lead you into a Tax Trap known as "double
taxation". Yes, income from a "C" Corporation can actually be
taxed twice -- once when it's earned on the corporate level and
again when it's paid to you, the shareholder, in dividends.
There are several ways to avoid double taxation. Often the
easiest way is to tell the IRS that you choose to be an "S" Corp
instead of a "C" Corp. The profits of an "S" Corp are not
taxable to the corporation; instead, those profits are reported
directly on the shareholder's personal income tax return and are
therefore only taxed once.
And once is enough, don't you think!
Of course, any article on Choice of Entity must contain the old
disclaimer, "Consult your tax professional" -- I am not
prescribing a one-size-fits-all approach to this issue. But for
many small biz owners and self-employed folks, the "S"
Corporation is a good fit because it provides protection from
personal liability and avoids the nasty tax trap of double
taxation -- two great benefits worth checking into.
Should you incoporate your sole proprietorship and then decide
that the "S" Corporation is the right fit, you must inform the
IRS that your corporation is choosing "S" Corporation status by
filing Form 2553, which is, in effect, an application to become
an "S" Corporation.
IMPORTANT: If you incorporate and do not file Form 2553, you are
automatically considered to be a "C" Corporation by the IRS. In
other words, to be a "C" Corporation, you just incorporate;
there is nothing you have to do to inform the IRS you want to be
a "C" Corporation.
There are critical rules regarding how and when to file Form
2553, so be sure to read the instructions carefully, or check
with your tax pro.
Failure to file Form 2553 on time or filing Form 2553
incorrectly results in a rejection of your corporation's "S"
Corp application, and the corporation is then by default treated
as a "C" Corp, subject to double taxation, the very trap you
were trying to avoid.
To download a copy of Form 2553, go to:
http://www.irs.gov/pub/irs-pdf/f2553.pdf
The instructions for filing Form 2553 are found here:
http://www.irs.gov/pub/irs-pdf/i2553.pdf
About the author:
Wayne M. Davies is author of 3 tax-slashing eBooks for small
business owners and the self-employed. For a free copy of
Wayne's 25-page report, "How To Instantly Double Your
Deductions" visit
http://www.YouSaveOnTaxes.com
