To Inc. or Not To Inc.

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Incorporate_101smIt’s Election Day, unless you are going to cancel out my vote in which case it is next Tuesday.  Liberal, Conservative and an all shades in between – I don’t know anyone who willingly pays more taxes than they owe (although you can here).  With the goal of paying lower taxes, many of my showbiz friends form S-corporations for themselves.  But should you?

Last week, a couple Chip’s Money Tips subscribers asked me that very question.  Unlike Harry Truman, I passed the buck to my accountant Ernest Hicks.  He is an Enrolled Agent.  If you have any questions about what he wrote, please click here to email Ernest.  Take it away, Ernie!

Chip,

Anyone may open an S-Corporation in order to do business.  An S-Corp  is one of several forms of Corporations.  Therefore there is some limit of liability by using an S-Corp.  An S-Corp as with any corporation should really be set up by an attorney to be sure that everything is in order and handled correctly.  It does no good to form a corporation, have a problem where you need the protection and find that you did not follow thru on something that effectively makes the corporation invalid.  If you need the protection, then it is better to pay the extra and have an experienced attorney set up the corporation.

 

In California all corporations pay a minimum of $800 per year just for the privilege of doing business in California.  Don’t be misled by false advertisements that you can incorporation in another state and eliminate that requirement.  If you live or do business in California then the likelihood is that you will have to file California corporate income tax returns.  Also you have the additional fees of having to have another income tax return prepared by your tax professional.

 

One problem many individuals have is not treating a corporation as a separate entity and comingling funds etc.  A corporation is a stand-alone entity and must not pay your personal expenses, and you do not pay the business expenses from your personal account.  You may borrow funds or loan funds to the corporation, but make sure they are well documented and keep good track of the amounts and dates etc.  If you pierce the corporate veil, then a suit can pierce the corporate veil also, eliminating the benefit of the corporation.

 

Many times someone tells my clients that they have heard you can deduct more in a corporation than you can as a sole-proprietor. I disagree for the most part. You have to spend a dollar to deduct a dollar, and generally no matter which entity you spend a dollar, it is deductible.

 

There are two areas where I believe you have more of a deduction as a corporation than as an individual.  If you cover all employees for health care, that is a deduction to the corporation that may be less deductible to the sole-proprietor or may only be partially deductible to the sole-proprietor.  If you are making enough money to put large amounts away for retirement, you can make larger contributions to qualified retirement plans as an employee of a corporation, and as an individual.  You will have to set up a payroll even if for only one employee, (yourself) and make monthly, quarterly and yearly payroll tax payments and payroll tax returns.

 

The pass through earnings from an S-Corporation or LLC are treated like a partnership and the individual pays taxes on the income.  The S-Corporation has an advantage at present, that after you take a reasonable salary for your time and experience, the remaining distribution from the earnings of the corporation does not have to be taxed for self-employment as they would if you were in you sole-proprietorship or as an LLC.  This savings could be hundreds up to thousands of dollars each year, but be careful this is then not helping you build your social security earnings for retirement.

 

There are so many variables, it is hard to send you to someplace that can answer your questions about if this is right for you.  Each business is different and you should meet with more than one attorney and tax professional to get advice.  I do believe that the estimated cost of a corporation of $3,000 per year is a reasonable guess.

 

As an S-Corp you definitely will need a bookkeeping system in place, you will have to pay yourself wages, and you can employ your (spouse) as a bookkeeper, but depending on your income, that may cost (your spouse) additional taxes.   Unemployment filing is another issue that can get tricky as you are in complete control of the corporation and if you are employed or not.

 

Sincerely,

Ernest Hicks

Thanks Ernie!  In the event that you are forming an S-Corp because you are actually concerned about liability and getting sued, you could save a few bucks and get an Umbrella policy from your insurance agent.  An Umbrella policy covers you for liabilities where your existing policies fall short in case you get sued.  Your insurance agent will give you more details, including pricing.  Ballpark figure, you can get roughly $1 million in coverage for $100.

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