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
