| How To Legally Save Thousands of Dollars a Year in Taxes by Incorporating |
Besides protecting your personal assets,
incorporating may slash your overall tax bill too!
Someone once remarked, "Next to being shot at and missed,
nothing is quite so satisfying as an income tax refund."
There's no question that saving money in taxes is high on
everybody's list of financial priorities, especially
self-employed business owners.
However, unlike individuals who work as employees for an
employer, business owners actually have the "luxury" of
choosing how much in taxes they pay each year by picking one
form of business entity over another -- such as a sole
proprietorship, partnership, corporation, or limited
liability company. Unfortunately, the majority of business
owners choose a business entity once (usually when starting
out) then keep the same entity for the life of the business.
This isn't necessarily always the smartest thing to do.
While some companies can get away with sticking with the
same form of business entity throughout the life of the
business, countless others are just simply throwing money
out the window by overpaying their taxes. For some smaller
business owners, this financial nonchalance can actually
cost an extra several thousand dollars in unnecessary and
avoidable taxes each year.
If you're a business owner concerned about reducing his or
her tax liability, here's a way you can dodge the tax bullet
by utilizing what's known as a Subchapter S corporation:
First some background: When starting a new business most
business owners focus on simplicity: that is, the less
paperwork and regulations to contend with the better. What
this means is that most new businesses start out as
"unincorporated" entities such as sole proprietorships (73%)
and partnerships (6%). While management and administrative
costs of running the business might be easier and less
expensive initially, the tax burden, especially the
self-employment tax, can be anything but.
For many business owners who wait till year-end to do their
tax planning -- or who do no tax planning at all -- the
self-employment tax is an unwelcome surprise -- and a very
large expense. Newly self-employed individuals are shocked
even more once they realize that they are responsible for
the self-employment tax all on their own. That's because
when they worked as an employee their employer was
responsible for paying one half of the self-employment tax.
Self-employment tax particulars:
The self-employment tax is simply a version of the same
Social Security and Medicare taxes you pay as an employee.
However, instead of paying 7.65% as you do when you're an
employee, as a self-employed business owner you have to pay
double: 15.3%.
In 2004, the Social Security portion (12.4%) is levied on
the first $87,900 of net profits. There is no limit to the
Medicare portion (2.9%).
Self-employed individuals are also entitled to a one
half-credit of the tax.
As an example, a self-employed individual with $100,000 in
net profits in 2004 would be required to pay approximately
$12,766 in self-employment tax. NOTE: This tax is in
addition to federal, state and local taxes!
Here's what you can do to save money on the self-employment
tax:
Incorporate and elect Subchapter S status. You can elect
Subchapter S status even if you have a pre-existing C
corporation too. Operating your business as an S corporation
is one of the very few four leaf clovers still left in the
tax code. The reason for this is simple: The net income from
an S corporation is NOT currently subject to the
self-employment tax.
If structured and implemented properly, an S corporation
could save you thousands of tax dollars per year. As an
employee-shareholder of your S corporation, you pay yourself
wages just like you would any other employee. But instead of
taking profits out through payroll, you take cash
distributions called "nontaxable dividends".
Nontaxable dividends are called nontaxable, because they
aren't double taxed like the dividends paid to shareholders
in a regular C corporation (although beginning in 2008
dividends will no longer be taxed). You're still paying
taxes on the net income of your S corporation when you file
your personal tax return, but the tax is federal tax and not
the self-employment tax.
For the sake of simplicity, if an S corporation with
$100,000 of pre-tax and salary profits pays its owner a
reasonable salary of say $50,000 and non-taxable dividends
of $25,000, the tax would be $7,650. This is a whopping
$5,116 savings in tax! Even if you factor in additional
costs such as workman's comp insurance, incorporation costs,
professional fees and incidentals, the savings is still more
than adequate.
Caveats
The key to the whole scenario is that your salary must be
reasonable under the circumstances surrounding your
business. It's also much better for salary justification
purposes if your business is not limited to the delivery of
personal services by you.
At personal income levels close to the Social Security wage
base , the benefits of using this strategy diminish. Here's
more good news: If you happen to already own a regular C
corporation and you live in a state that has a high
corporate income tax rate, you'll come out ahead even more
if you elect S status. Additionally, if you have children
aged 14 or older, you can save even more taxes by giving
them shares in your S corporation and having them pay the
tax at their lower tax rates. By giving away shares you also
reduce your estate tax obligation.
So you see, there are plenty of good reasons to incorporate
and elect S status. I've only touched on a few minor points.
There are many other valid reasons to incorporate. Just keep
in mind that you should always consult with your tax advisor
for your particular needs and circumstances before making
any important business or financial decisions. Besides
taxes, there are many legal and financial issues to contend
with as well. Always look before you leap.
When it comes to your business, you should make it a point
to assess the validity of your type of business structure on
a yearly basis. Incorporating is definitely not just for
startups. There are plenty of unincorporated businesses that
are missing the boat when it comes to saving money. Don't be
one of them. It pays to find out more.
============================================================
Alex Goumakos, CPA has over 20 years of experience helping
entrepreneurs start and grow successful businesses. If
you're ready to earn more money, pay less tax and generate
more wealth, visit his website for FREE tips, strategies and
tools to help turn your goals into results.
http://www.goldminetactics.com
============================================================
|
Back to Articles Index
|
|
 |
|
