One of the biggest advantages of a business being a corporation is the separate legal entity status which allows it to act as just like an individual. Most importantly it legally separates the owners and the business and therefore owners do not have personal liability for the debts of the company. Interestingly most of the industry leaders in the business world are corporations. For instance Microsoft, General Motors, Dell or Wal-Mart, all are successful corporations which are pioneers in their respective industries. I believe one of the reasons for their success stories is that the ability of the senior management to take significant risks at crucial times.
The objective of this article is not however to discuss the general advantages of being a corporate but to elaborate more on the tax benefits enjoyed by these corporate entities. In a summary we want you to know that one of the most overlooked, yet most beneficial, ways to help save on taxes in a business is to form a corporation.
Do you know that corporate profits are not generally subject to many taxes such as Social security, Medicare, Workers compensation and many more? This is a tax holiday of around 15% when combined. This further means a sole proprietor would need to pay all of the previous taxes on all income earned by his business whereas in a corporation only salaries are subject to these taxes.
Generally 15% tax is imposed on corporate profits. But if you are a C-corporation, you can enjoy even greater tax flexibility using dividends to divide income between the corporation and the shareholders. This is a very effective tax planning tool which helps businesses save thousands of dollars on taxes each year. However, when cash dividends are declared, it results in a double taxation of the same income. Therefore shareholders might get de-motivated. As a remedial measure we can always pay out the dividends in the form of a bonus issue or else we can entirely prevent from paying dividends although the second option would seem to cause some other issues.
Apart from that, unlike Sole Proprietorships, Corporations have very few restrictions on operating and capital losses. The losses are commonly carried back three years and can be carried forward for 15 years. On the other hand Sole proprietors not only have more stringent rules, but also are subject to a higher probability of audit for verification purposes if there are losses.
Other monetary benefits
- Although a corporation may deduct other expenses such as automobile insurance, education benefits and life insurance from taxable profits it may not be permitted to sole proprietors in many occasions. In addition due to the suspicion these generate, it can trigger IRS to call audits for individual owners.
- Similarly corporations can deduct 100% of the health insurance premiums paid on behalf of an owner-employee. However, only 60% of the medical premium is currently deductible for the sole proprietor filing a personal claim.
A lot of people opt to own sole proprietorships mainly because of the less informal structure and procedures required in the business. However there are many financial advantages of being incorporated. Though you feel comfortable with your sole proprietorship today, the chances are you may consider incorporating tomorrow especially if your business is growing at a considerable rate. As the situation differs case by case you may consult a qualified tax or legal professional to discuss your specific circumstances and to maximize your tax benefits.
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