Is Incorporation Right for Your Business?
by Frances Rahaim, Ph.D.aka "The Money Doctor"
Another tax season has passed, and for many business owners who have recently sent in their federal and/or state tax payments, it can be an occasion for small celebration. A toast perhaps? Your business has survived another year’s tax burden.
For large and medium-sized companies, tax time may come and go as a matter of course. Their accounting departments have been projecting and building in their tax payments all along during the year, and when it’s time to pay tax, they remit a check as part of doing business.
But for the thousands of sole proprietors running small businesses on their own, tax time can mean a sizable dent in their profit margin. Depending on the year’s revenues and the business’s financial structure, that April 15 deadline each year could represent writing checks to the government for four or five figures.
I don’t know any business owners who consider that an enjoyable task.
But now that tax time is freshly behind us, it might be time to consider strategies for next year’s tax bill.
One way to potentially save thousands of dollars every year in taxes is to incorporate your business—specifically, to become an S-Corp (S referring to Subchapter S of Chapter 1 of the Internal Revenue Code).
Many sole proprietors and small business owners have an unclear understanding or the wrong impression of incorporation. Incorporating a business is prohibitively expensive, some assume, or incorporation only applies to larger businesses with lots of employees, not my sole proprietorship. It makes tax filing too complicated, or it’s too difficult to incorporate.
None of those assumptions is necessarily true. Incorporation is available to small business owners and sole proprietors, and may make sense at tax time, and for several additional reasons.
I want to make clear that I am not an accountant, and I am not an attorney. But I am a business owner, and I have incorporated virtually all my businesses. I don’t necessarily recommend incorporation for all businesses, but it may be something for sole proprietors to consider.
For one thing, by incorporating your business, you may save money on the Self-Employment Tax, a payroll tax for Social Security and Medicare. When you incorporate, your personhood is removed from the business, so a portion of Social Security and Medicare payroll taxes is no longer required.
The tax savings alone might be worth it to incorporate your business, but there are other tax advantages as well. As a corporation, you can determine when you receive income, so that you can position your income to be received at a time when you’ll pay less in tax. As a corporation you can potentially defer tax payments until a later time, which might turn into lower tax bills. Your incorporated business may qualify for a small business tax deduction.
Also, importantly, being incorporated might increase your business. In addition to the added credibility that automatically comes with adding “Inc.” to your business name, some companies will only conduct business with incorporated companies, because of liability issues. Which brings up another important benefit of incorporating. Protection of assets from liability may vary depending on corporate structure, but incorporating your business can add an extra layer of protection from law suits and other financial liabilities.
To be sure, incorporation is not the right answer for every business. There are disadvantages to incorporating, too, including less tax flexibility, some added paperwork, and some expense getting registered as a corporation.
Ask your accountant and attorney if becoming a corporation is the right move for your company. My experience has been that the process costs about $500 in attorney and other fees, even less if you file the forms yourself. You may wish to visit irs.gov to review the appropriate incorporation before making your decision.
Incorporating may require some expense up front, but it could turn into savings many times over each year at tax time.
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