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Advantages to Incorporating

Advantages to Incorporating
When you think of corporations, you generally think of the larger companies, such as  GE, Microsoft, Apple, or Google.  However, you can enjoy the same protections and advantages as they do by setting up your own corporation or limited liability company.  A corporation or a limited liability company is a legal entity that has a separate existence from its owners.  Both LLC’s and corporations can be set up with just one owner, or multiple owners.   There are some compelling advantages to forming a company to operate your business.

Protection from Personal Liability

Forming a legal entity, either a limited liability company or a corporation, is one of the best ways to protect a business owner from personal liability.  Shareholders of a corporation and members of an LLC are generally not liable for the obligations of the company.  Creditors of a corporation or LLC may seek payment from the assets of the entity, but not the assets of the shareholders or members.  This means that business owners who operate through an entity may engage in business without risking their homes, vehicles or other personal property.

Self-Employment Tax Savings

Corporate profits are not subject to Social Security and medicare taxes (referred to as “Self Employment taxes”) which is a combined rate of 15.3%.  A sole proprietor and partners in a partnership are required to pay Self Employment Taxes  on all wages they pay themselves that is earned from the business.  In a corporation or an LLC taxed as a corporation, only salaries are subject to these taxes, but dividend payments are not subject to Self Employment taxes.

For example, if a sole proprietor paid himself $60,000 in wages from his business, a 15.3% tax  would  be paid on the entire $60,000.  Now, if that sole proprietor formed either a corporation or an LLC taxed as a corporation, the owner is required to pay himself a reasonable salary and he can also pay himself a dividend payment based on the profitability of his business. If you hold stock in Apple, you receive a dividend payment when the company performs well.  If you operate your company so it performs well, you can receive a dividend payment representing the profits of your company.

In our example, we said the business owner is paying himself $60,000 in total compensation.  Since the owner works for the company, he must first pay himself a reasonable salary (more on this below).  In this case, the business owner worked with his accountant and they determined a reasonable salary for his job was $40,000 a year.  Remember we said the total compensation was $60,000.  Since he paid himself $40,000 in wages, the remaining $20,000 can be paid as company dividend or company profits.  He would have to withhold the normal W-2 withholdings on his salary ($40,000), but he only has to pay state and federal taxes, not the 15.3% Self Employment taxes, on the $20,000 dividend payment.  This structure provides the  the owner of the corporation or LLC a tax savings of $3,000 on the dividend payment.

Please note that a shareholder who is also an employee of the company must pay himself or herself a reasonable salary, or else the IRS could re-characterize some or all of the corporate profits as salary.  It is important to work with your accountant to determine what constitutes a reasonable salary for your particular profession.   You can also check out the Department of Labor’s Website.  This site provides statistics from the Bureau of Labor Statistics and it provides wages by area (i.e. Phoenix, AZ) and occupation.

Overall, incorporating is one of the best ways for a business owner to protect his or her personal assets, strategically structure the business while saving thousands of dollars in taxes.  Since individual situations differ, please consult a qualified tax or legal professional to discuss your specific circumstances and to maximize your tax benefits while reducing your liability.