Why Incorporate?

Advantages of Incorporation

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 (LLC).  A Corporation or a Limited Liability Company is a legal entity that has a separate existence from its owners.  Both LLCs 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.  (Find more information on the differences between Corporations and LLCs here).

♦ 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 LLC that is taxed as a corporation, only salaries are subject to these taxes; dividend payments are not subject to Self-Employment taxes.

Scenario:  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.

If that Sole Proprietor formed either a Corporation or an LLC taxed as a Corporation, she can still pay herself $60,000 in total compensation.  The owner is required to pay herself a “reasonable salary”; in our example, the business owner and her accountant determined a reasonable salary for her job was $40,000 a year.  She also paid herself a company dividend of  $20,000 based on the profitability of her business.  She would withhold the normal W-2 withholdings on her salary ($40,000).  However, she only has to pay state and federal taxes on the dividend payment ($20,000). The owner does NOT pay Self-Employment taxes (15.3%) on dividend payments.

Filing as a Corporation or an LLC taxed as a Corporation gives the owner a total tax savings of $3,060 on the $60,000 compensation package.  The table below demonstrates the scenario.

Total Savings for filing as a Corporation: $3,060

*Reasonable Salary: 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 which provides statistics from the Bureau of Labor Statistics and 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 and 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.