Imagine you’ve started the business of your dreams. You have a bunch of amazing clients and customers, and things can’t be better.
Then, taxes come along, and you wonder about the tax benefits of incorporating. While incorporating isn’t for everyone, it offers quite a few financial advantages.
Read on for more.
- 1 Set a Salary
- 2 Lower Self-Employment Income Tax
- 3 Deduct Losses
- 4 Deduct Salaries
- 5 Deduct Benefits
- 6 Deduct Other Expenses
- 7 More Separation
- 8 Make Your Kids Shareholders
- 9 Hire Your Spouse
- 10 Carry Profits and Losses
- 11 Donate to Charity
- 12 Attract Passive Investors
- 13 On Corporate Tax
- 14 Simple to File
- 15 Access Corporate Tax Credits
- 16 How to Incorporate Your Business
- 17 Is Incorporating a Business Expensive?
- 18 Should You Incorporate a New Business?
- 19 Do You Need Employees or a Business Partner to Incorporate?
- 20 Are There Any Drawbacks to Incorporating?
- 21 Do the Benefits of Incorporating Outweigh the Risks?
- 22 Learn More
Set a Salary
One of the most significant benefits of incorporating your business is to pay yourself a salary. If you work as a sole proprietor without any sort of incorporation, you will automatically receive all of your business profits as income.
Taking home all of your business profits can be nice at first. However, once you start making more money, you will incur higher taxes if you take all of the profits as personal income.
Incorporating a business allows you to set a salary like you’d earn at a traditional job. You’ll know how much you’ll make that year, and you can set your salary high enough to cover your expenses without paying a ton in taxes.
Depending on your business, your business may also owe taxes. But you may get a lower tax rate for your corporation than you’d pay if all of that money went to your bank account.
Lower Self-Employment Income Tax
Whether you take a salary or not, you may have a lower tax rate when you have an S corporation. You can take your pay as non-taxable dividends, which will still be subject to some taxes.
However, you won’t have to pay self-employment tax on that income, which can save you about 15%. If you take a lot of money in dividends, not paying self-employment tax can result in massive savings.
You will still need to pay income tax, so you won’t get to keep all of the money you earn in dividends. Still, non-taxable dividends can be a great tool for you to save money.
Another one of the advantages of incorporating is that you can deduct losses from your taxable income. You can do this on your personal tax return if you have a limited liability company (LLC) or an S corporation.
When you have a C corporation, you’ll be able to deduct losses on the company’s tax return. Either way, you will be able to lower the amount of taxable income, which can help lower your tax bill.
This is a nice benefit for new businesses that have yet to become super profitable. Even after you make a profit, if you experience losses, you won’t have to worry about paying taxes on all of the money you and your business take in.
If you’re considering hiring employees, incorporating a business is an excellent option. When you have a corporation, you and your employees will owe FICA and Medicare taxes like anyone else.
You will also need to account for payroll taxes and withhold those from your employees. However, you may be able to deduct the amount of money your company spends on payroll taxes.
When giving out salaries and bonuses, you should be strategic about the timeline. Many companies give bonuses at the end of the year, and doing this can help you save money.
If you give bonuses to your employees, you can lower the amount of taxable profit. Now, you don’t want to do this too much because it may not look good to the IRS, but it’s a good way to lower your tax bill and support your employees.
Another great tax benefit of hiring employees for your corporation is that you can deduct benefits. You can spend money on benefits such as health insurance premiums, tuition reimbursement, and other fringe benefits.
Then, you’ll be able to deduct those expenses from your taxable income. Of course, you need to make sure you can afford these benefits without eating into your profit margins.
If you can afford them, take advantage of these deductions. Offer the best benefits you can to attract employees who will want to stick around, so you can keep accessing these deductions.
Deduct Other Expenses
At some point, you will probably face other expenses to keep your business running. You may need to pay for office space, computers, and office supplies for you and your employees.
Other business expenses include utilities, advertising, and business insurance. Be sure to keep receipts for all of your business transactions to make reporting them on your taxes much easier.
In some cases, you may be able to deduct travel costs and other things you spend money on for your business. If you aren’t sure if you can deduct a certain expense, talk to an accountant.
They can review your specific business to help you determine if an expense qualifies for a deduction. That way, you won’t have to worry about missing any deductions when you file your taxes.
Maybe you don’t plan on hiring employees right away, but you’re still considering the benefits of incorporating. Another advantage of having a company is that it can separate your business and personal finances.
Many business entities are pass-through entities, so you may not have to file separate tax returns. However, you can protect your personal assets, such as a home or car, from business activities.
If someone decides to sue your business, they will only be able to go after what your corporation owns. They won’t be able to get your car or house or anything else that you own outside of your company.
Sole proprietorships and general partnerships don’t have this protection. While you may not need legal separation now, it never hurts to prepare for the future.
If you want to lower the amount of money you’ll make in taxes, you can offer shares to your kids. As long as they’re at least 14 years old and you trust them, they can own part of your business.
You’ll pay them dividends for their work in your company. However, the amount they have to pay in taxes will be less than what you’d pay if you kept the share for yourself.
Not every kid will want to be a shareholder, so this strategy doesn’t work for everyone. If your kids are willing to work with you and they care about your business, you can all save on taxes.
Hire Your Spouse
Another excellent benefit of incorporating for business owners with families is the option to hire your spouse. You can hire them with or without a corporation, but hiring them after you incorporate offers unique advantages.
If you hire your spouse, you can pay them mostly in fringe benefits, such as retirement savings or tuition reimbursement. You don’t need to pay any wages to your partner when they work for you.
That means you can both save money if you file your taxes jointly. You’ll only have to pay taxes on the income you take from the business since you don’t have to pay taxes on most benefits.
If you need help and your spouse is willing, this is a fantastic way to lower your taxable income. You can deduct the benefits from your business taxes and keep from increasing your total taxable income on your personal return.
Carry Profits and Losses
When you set up a C corporation, you can carry profits and losses from year to year. This way, you can set everything up to give yourself and your business the biggest tax benefit.
For example, maybe you don’t make that much money but have a lot of losses one year. You know that you’ll probably make more the next year, so you decide to carry the losses from the first year into the second.
Now, you can’t use these losses to save money on taxes for multiple years. If you report the loss and take the benefits, you can do that again, so this isn’t the best option if you’re already making a profit.
However, when your business has yet to make a profit, it can be worth considering. Then, you may save money on taxes for the first few years you become profitable.
Donate to Charity
Another one of the benefits of incorporating as a C corporation is the option to donate to charity. Individuals can deduct the amount they donate to non-profits on their tax returns, and the same applies to corporations.
If your business donates money to charity, you can deduct the amount of the donations up to 10% of your taxable income. That can help you lower your tax liability, especially once you start making money.
You can also make your charitable donations a huge part of your business. If you market your company as one that likes to give back, you may get more orders to help grow your revenue.
Continue Reading ” Tax Benefits of Incorporating” to learn additional tax benefits that can help save you more money.
Attract Passive Investors
If you need money to help grow your business, investors can help, but they may face taxes with some business structures. Luckily, a C corporation lets passive investors save on taxes when they make money.
You can form a C corporation and use the structure to attract people who want to invest but don’t want to work on the business. That way, you’ll be able to maintain control of daily operations.
While you’ll still have to pay taxes on your earnings, you can use the corporation as a huge selling point for investors. Then, you may be able to attract more investors than you would if you had a different business entity.
On Corporate Tax
One of the benefits of incorporating as something other than a C corporation is not having to pay corporate taxes. Other structures are pass-through entities, which means owners and shareholders report income on their personal tax returns.
If you have a C corporation, you may need to pay double in taxes. You’ll have to pay taxes on your salary as well as on the profits that your business earns.
When you have an LLC or an S corporation, you will only need to pay on your personal return. That can help you save a lot of money, especially in years when the corporate tax rate is high.
You can pay yourself a salary with a lower tax bracket so that you have the money you need. However, you won’t need to pay as much in taxes overall.
Simple to File
If you decide to set up an LLC, you also get the benefit of a relatively simple tax return. You can make your LLC a disregarded entity, which is one that the IRS doesn’t recognize as being separate from its owner.
The structure is still separate when it comes to assets and liabilities, though. If you choose to set up your LLC this way, your taxes will be very similar to if you run your business as a sole proprietorship.
You’ll still have to worry about tracking your income and expenses. However, you won’t have to worry about dealing with multiple tax returns or other documents.
Filing your LLC as a disregarded entity offers you the tax benefits of a sole proprietor with the legal protections of a corporation. It’s a nice compromise if you can’t decide how to incorporate.
Access Corporate Tax Credits
You already have access to certain tax credits as an individual. However, incorporating yourself or your business opens you up to special corporate tax credits.
Popular credits for corporations include the general business credit, investment credit, and work opportunity credit. You may also qualify for other credits if you hire certain types of people or if you operate in a specific way.
The nice thing about tax credits is that they directly lower your tax bill. Even if you have a C Corp that pays taxes separately from you as a person, you may not pay that much more if you qualify for a lot of credits.
Credits are a lot easier to estimate than deductions. With a tax deduction, your taxable income drops rather than your tax bill specifically.
How to Incorporate Your Business
Now that you know the Tax Benefits of Incorporating, If you want to take advantage of the benefits of incorporating your business, you should understand how the process works. You should be able to set up a business whether it’s new or you’ve had your company for a while.
Whether your goal is saving taxes or protecting yourself legally, you should incorporate. Then, you can save money now and in the future, which is great if your business grows significantly.
Here are a few steps you can take as you incorporate your business.
Select an Available Name
You’ll need to choose a business name that is available in the state where you want to register your business. Some websites offer databases that allow you to see if a name is available.
If the name you want isn’t available, you can choose another name to register. Then, you can set up a Doing Business As (DBA) name so that you can operate under the name you want.
When setting up a new business, think about the products and services you offer. That way, you can choose a business name that makes sense and can help you get customers and clients.
Decide on a Corporate Entity
The next step in incorporating a business is to choose a corporate entity. Limited liability companies (LLCs) are useful because they’re simple but offer good legal protection for you and any other owners.
A C corporation is a smart choice if you want to access more corporate tax benefits, such as donation deductions. The corporation can be of any size, and you have access to more stocks and investments.
If you plan to keep your business small, an S corporation may be the better choice. It’s similar to a C corporation, but you can’t have more than 100 shareholders, and you can only have one class of stock.
Get an EIN
You’ll also need to apply for an employer identification number (EIN). An EIN isn’t necessary for a single-member LLC or a business with no employees, but you can still get one if you want.
When filing taxes for your business, you will use your EIN. Having an EIN can also help you separate business from personal because you would need to use your social security number (SSN) if you didn’t get an EIN.
Be sure to keep your EIN safe and treat it like another SSN. That way, you can keep people from accessing information about your business or trying to impersonate you or your company.
Set Up a Bank Account
If you haven’t already, you should set up a separate bank account. You can use your EIN to create the account if you have a corporation, which can further separate your business finances from your personal accounts.
Use the business account to take payments from clients and to pay your business expenses. This will help you keep track of everything, which will make it easier to file your taxes at the end of the year.
While you may be able to use one account for everything, that won’t be practical as your business grows. It’s better to start separating everything at the start so that you don’t have to deal with it later.
Is Incorporating a Business Expensive?
When you incorporate a business, you will need to pay a fee to your state. Some states charge tens of dollars while others charge hundreds of dollars to set up a corporation.
The specific cost can also depend on the type of business entity you want to set up. In general, an LLC costs less to form than a C corporation, so that may affect which structure you choose.
You should also prepare to pay an annual renewal fee to keep your business up and running. Then, you can maintain the same tax status to enjoy the benefits of incorporating.
Should You Incorporate a New Business?
If you want to hire people right away, you should incorporate a new business. However, you don’t need to incorporate right away if you plan to work independently.
When you grow and need to hire, you can switch from a sole proprietorship to an LLC or corporation. That way, you can make sure you’ll enjoy working for yourself and on this specific business.
If you know that you want to run a company and do something in particular, it doesn’t hurt to incorporate early. You won’t have to rush to set up a corporation later on when you need to hire employees.
Do You Need Employees or a Business Partner to Incorporate?
You don’t need employees or business partners to incorporate. If you work on a freelance basis, incorporating can still provide a lot of benefits, from lower taxes to legal separation.
However, if you have employees, it’s very beneficial to incorporate. That way, you won’t have to worry about them suing you or coming after your personal belongings.
You may want to incorporate when you have a business partner. Even if you trust the other person, incorporating can protect you if your partner doesn’t do what they’re supposed to.
Are There Any Drawbacks to Incorporating?
The biggest drawbacks to incorporating happen when you first set up your business. It can take a lot of money to register for an LLC or corporation, and you have to keep paying that fee each year.
When you first set up the entity, you may also need to wait for your state to process your documents. That can take time, and it may keep you from being able to operate your business right away.
Fortunately, once you get your corporation going, there aren’t many issues. The benefits usually outweigh the problems with forming a corporation.
Do the Benefits of Incorporating Outweigh the Risks?
When deciding how to structure your business, you should consider the benefits of incorporating. While you can work as a sole proprietor, you may miss out on tax savings and other advantages.
Now that you know the Tax Benefits of Incorporating, be sure to consider different structures, such as LLCs and corporations. Then, you can decide which type of business is best for you.
Do you want to compare how much you may owe on taxes with different business structures? Use an income tax calculator.