Two Advantages to Forming a Corporation Liability and Taxes
A corporation is a separate legal entity that acts as a single person and is created under statutory law.
The corporation owns the business and, in turn, the corporation issues shares of stock to individuals investing in the corporation.
Corporations deliver two huge benefits to business owners. One benefit is a legal benefit and the other is a tax benefit.
Benefits of Forming A corporation
The big legal benefit that corporations provide business owners with is liability protection. What this means, practically speaking, is that the business owners are not liable for the debts of the business.
A second benefit of corporations relates to the income and payroll taxes that a business pays or that investors pay. As a general rule, small business corporations provide two tax benefits to their owners.
The first potential tax saving associated with incorporating your business applies to what the tax laws call a C corporation.
A C corporation can typically provide tax-free fringe benefits to all of its employees such as medical insurance, reimbursement of medical expenses, a modest amount of life insurance, employee housing (in some cases), and so on.
A corporation also affords its owners a second potential tax saving opportunity, Subchapter S status.
Regular C corporations and their employees pay income taxes.
In addition to income tax, each business owner also pays an employment tax equal to roughly 15% on the first $100,000 of profit and then roughly 3% on any profit above $100,000.
Things work differently if the corporation elects to be treated as a S corporation. In this case, the corporation sets the shareholder-employee’s wages to a low but reasonable level. Perhaps this means wages equal to $60,000 annually.
In this case, the employment tax equals 15% of only the $60,000 in wages, or $9,000 instead of the entire business profit.
Costs involved for operating a corporation
When you consider the benefits of a corporation -limited business liability and tremendous potential tax savings - you seemingly have almost the perfect business entity choice. So an obvious question is “Why wouldn't everyone become a corporation?”
- A corporation will probably increase your banking, accounting, and insurance costs.
- A corporation will need to do quarterly and annual payroll tax accounting - even if the only employee is the owner.
- A corporation needs to file its own tax return. And this tax return may cost anywhere from a few hundred dollars to a few thousand dollars annually.
- A corporation may involve several hundred or even a few thousand dollars of start-up expense to incorporate.
- A corporation needs to have a board of directors meeting regularly such as monthly, quarterly or annually, and annual stockholders meetings.
Typically, the incorporation option is uneconomical for very small businesses.
On the other hand, any business that’s producing profits that equal or exceed what the owner would earn if he or she worked as an employee for someone else probably should operate as a corporation or as a limited liability company.
In these cases, the corporation economically reduces business risk.
Books on Forming A Corporation
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Limited Liability Company - The Benefits of Forming An LLC
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