September 25, 2020
Everyone, from small business owners to independent contractors, knows there some extremely specific advantages to incorporating. Not only do you receive some protection in case of liability, since the business is held liable, instead of you – the individual owner – (although this depends largely on the circumstances, of course), but incorporating also sets you up to be eligible for plenty of tax breaks.
Since different types of corporations are taxed at varying rates, they are also eligible for many tax breaks that individuals are not. Without a doubt, sifting through the incorporation paperwork may help you quite a bit when filing your yearly federal and state tax returns. But overall, there are five main ways that you can save money on your taxes, simply by incorporating your business. So, you need to be aware of the following advantages when making any big decisions:
1) You Won’t Have to Pay Self-Employment Tax
Self-employment taxes add up quickly. They make a large portion of the amount of money that you make every year as a non-incorporated business owner or independent contractor. The reason for this is the fact that you need to make up for the amounts that a standard company would pay as a part of your salary. Medicare and social security both need to be paid, and they are added onto the tax liability of an independent worker. And yes, while they do come out of an employee’s salary, it’s important to note that a portion of them are paid by the company. However, when you’re an individual, you need to pay both of these parts yourself.
However, if you incorporate your business, this changes. The salary that you pay yourself through the company isn’t subjected to these additional taxes. Instead, your company is. This lowers your overall tax liability as an individual and puts you on the same equal footing as the average worker. Plus, the owner of a corporation can pay themselves in dividends, as opposed to just issuing a salary. The tax rate qualified dividends can be as little as zero. This is another way to save yourself from having to pay the hefty self-employment tax and save money on your taxes overall.
2) You’ll Receive Additional Tax Breaks
There are numerous tax breaks that a corporation can deduct from its overall tax liability that individuals simply aren’t eligible for. For example, contributions to a pension aren’t taxed as income, and both dividends and long-term capital gains are taxed at much lower rates. While smaller corporations, such as those run and staffed by a single person, may not have either of those things, it’s good to know that if you do, your company’s tax liability will be lowered.
Also, corporations can often deduct the amounts that they pay for their employees’ health insurance. This is yet another example of the many different tax breaks and deductions that corporations receive on the federal level. There are many others, as well as a number of deductions and tax breaks that these businesses can receive on the state level as well. The IRS rewards companies with many different benefits like this, because they keep the country running by employing people and providing both goods and services.
3) You Can Carry Losses Forward
Corporations have an additional advantage that independent contractors and sole proprietors do not – they can carry their losses forward. How does this work? Well, if the business loses money over the course of a year, instead of ending up with profits, that amount can be subtracted from future years. In fact, for up to seven years after the year that the losses occurred, your business can subject those funds from their profits, thus paying less money in taxes that year.
For example, in 2018, let’s say your company lost $50,000. That amount can be carried forward to the next year. So, in 2019, when your business files their taxes and you realize that you made $90,000, that $50,000 from 2018 can be subtracted, making your profits $40,000, or less than half of what you actually made. This greatly lowers the amount of federal taxes that you need to pay that year. Or you can apply only a portion of that loss to your taxes, saving the remainder of it for the following years. Since you have seven years that you can apply this loss to, it can be spread out, lowering your tax liability for years to come.
4) Switching Corporation Types Can Lower Your State Taxes
The type of corporation that you choose to have can help you save money on taxes as well. There are four main types:
S Corporations – S corporations rely heavily on their shareholders. Things like the corporate income, as well as any losses, deductions, and dividends, end up getting passed through those shareholders. The company itself is not responsible for those amounts at tax time, the shareholders are.
C Corporations – A C-corporation is different because the losses, income, dividends, and so on do not pass through the shareholders. Instead, the company takes on the tax liability, paying it either quarterly or yearly. It is taxed separately from the owners and shareholders.
LLCs – An LLC is a combination of a standard corporation and a partnership. It is subject to a different tax structure than the previous types of corporations.
Nonprofit Corporations – Although a nonprofit is indeed a type of corporation, it is subject to specific regulations and all money made needs to go back into the corporation itself. Many corporations do not qualify for this status, but for the record, a nonprofit does indeed save money by maintaining an extremely low tax liability.
Each of these corporations is subject to different state tax laws. Switching from one to another, for example, from a C corporation to an S corporation, can drastically change the amount of taxes that you and your business need to pay.
5) Incorporated Accounting Methods Prevent Expensive Mistakes
An incorporated business has to follow a special accounting method that uses two different sets of books that contain the same information. One is for debits, the other for credits. This double-entry method is designed to allow for a series of checks and balances. If you don’t end up with the same numbers at the end of the year (or quarter, depending on how often you file), you know that there was an issue on one of the balance sheets. You can then fix it before you fill out your tax return, making you less likely to end up filing an incorrect return that could end with your business getting penalized with an audit, fines, or worse consequence.
The IRS and the state have a system in place for catching these errors and will inform you when something seems awry. How does this help you save money on taxes? Well, the fines from filing an incorrect return can add up quickly and add to your overall tax burden. You will save money on your taxes by catching these errors right away, before your return is filed. The single accounting method used by independent contractors and non-incorporated business owners isn’t set up this way.
Consulting with a Tax Expert
Before you make any drastic or monumental decisions regarding your business, it’s important to consult with an expert. Someone who has plenty of experience when it comes to incorporating businesses and the tax rates – and breaks, including deductions – that go along with it can help you get everything right. The process of incorporating can be lengthy, as it often involves plenty of paperwork. Depending on what state you’re in, there are numerous things to include in this information, and you could end up getting penalized if there are any mistakes.
Checking with an expert before you move forward, as well as having them help you with all of the paperwork – and, of course, your first few tax returns as an incorporated company – will ensure that you do everything correctly. After all, there’s nothing worse than making changes to save on your taxes only to get penalized in the end.
If the benefits of incorporating your business in order to save money on taxes is something you are interested in, the tax advisors at the Enterprise Consultants Group can answer your questions, discuss your rights, and provide actionable options. Please contact us online or at (800) 575-9284 today to schedule a free and confidential consultation to see how we can help you.
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