Benefits of Incorporating
By Bernard Fruchtman, Esq.
(This article is excerpted from TaxTalk -Plain & Simple)
As a new year begins it’s an excellent time to examine the legal structure that you’re using to operate your business. If you’re conducting your business as a sole-proprietor you may be missing out on getting the benefits of some potential tax saving techniques. A corporation is a separate legal entity from the person who owns it. This means that if the corporation enters into business deals, owns property, borrows money or conducts other business activities that you, and your personal assets, will in most cases be protected from personal liability. Only the corporation’s assets will be at risk to satisfy claims against the corporation.
Alert: The protection from personal liability is not absolute. For example, it can not protect you from liability in the following situations:
- Liability for “trust fund” taxes (i.e., payroll taxes and sales taxes).
- Professionals such as doctors, lawyers and accountants are personally liable.
- Certain state laws. For example, some state laws make certain shareholders of a corporation liable for unpaid employees’ salary.
Most persons incorporate to gain protection from personal liability. However, if this protection is not sufficient inducement to get you to put up with the additional paperwork and expenses that go along with incorporation, perhaps a tax saving technique that will save money on payroll taxes will be enough to convince you to incorporate.
In addition to the potential savings on payroll taxes, discussed below, there are many other tax saving techniques that are available to incorporated business entities. They will be discussed in future issues of TaxTalk – Plain & Simple.
Self-employment taxes are imposed at the rate of 15.3% on the first $68,400 (1998 base) of self-employment income and at the rate of 2.9% on all self-employment income above $68,4000. Self-employment taxes apply to all the income earned by a sole-proprietor. This is true even if the owner leaves some of the earnings in the business.
However, if you operate your business through a S-corporation only earnings actually paid to an owner as compensation for services rendered 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.
Payroll Tax Savings Example
Assume your business nets (gross income less expenses) $65,000 in 1998 and you withdraw $45,000 as salary leaving the rest in the business to help you pay for expansion or to purchase new equipment in 1999. If you conduct the business as a sole-proprietor in 1998 you’ll owe self-employment tax on the full $65,000 (($65,000 x 15.% = $9,945).
However, if you incorporate your business and elect S-corporation status and receive only $45,000 as compensation for services rendered, you’ll only owe self-employment taxes on the $45,000 in salary ($45,000 x 15.3% = $6,885).Thus, incorporating will save you $3,000 in payroll taxes. Most likely the savings in payroll taxes will be more than enough to offset any addition legal and accounting expenses that result from incorporation.
Employer Identification Number
If you decide to incorporate an existing business make sure you get a new Employer Identification Number (EIN). When you start a business the IRS assigns you an EIN. That number should be used only as long as you are doing business in the same form.If you change from doing business as a sole proprietor to a corporation you must get a new EIN. You can apply for an EIN by filing Form SS-4 (Application For A Employer Identification Number).
Alert: Failure to get a new EIN will result in confusion, likely correspondence with the IRS and could result in your being held personally responsible for taxes that belong to the new entity.
Bernard Fruchtman, Publisher/Editor of TaxTalk – Plain & Simple. TaxTalk – Plain & Simple, is a monthly newsletter that helps you save money by reducing your taxes. An annual subscription is $48 per year. For more information and a FREE ISSUE see web page at: http://village.ios.com/~taxtalk orsend your regular name and address to TaxTalk, Inc., 1562 First Ave., New York, NY 10028