Form Your Own Corporation and Save Money in Taxes
By Masood Khan

Are you an entrepreneur, small business owner or physician who wants to incorporate? Forming an S-Corporation may save you from paying more taxes. Many entrepreneurs have two goals in mind when choosing a structure for their business: protecting their personal assets from debtors and lawsuits and avoiding having the business profits taxed on their individual tax returns. Let’s first look at the benefits of incorporating your business.

Limited Personal Liability
You have probably heard that forming a corporation provides "limited liability." This means that the owners' personal assets are protected from creditors of the corporation. For instance, if a court entered a judgment against your corporation saying that it owes a creditor $100,000, normally you wouldn’t be forced to use personal assets, like your home or car, to pay the debt. Because only corporate assets need be used to pay business debts, you stand to lose only the money that you've invested in the corporation.

Exceptions to Limited Liability
You should be aware, however, that there are a number of circumstances in which limited liability will not protect an owner's personal assets. An owner of a corporation can be held personally liable if she, among other things:
· personally and directly injures someone
· personally guarantees a bank loan or a business debt on which the corporation defaults
· acts fraudulently or illegally and causes harm to the company or to someone else, or
· treats the corporation as part of her personal property, rather than as a separate legal entity.

This last exception is the most important. Courts may rule that a corporation doesn't really exist and that its owners are really doing business as individuals who are personally liable for their acts if it is found that the owner is intermingling his own assets and accounts with the accounts and assets of the corporation. If a Court holds an owner liable for such acts, it is said to have “pierced the corporate veil.” This might happen if you fail to follow routine corporate formalities such as:
· adequately investing money in the corporation
· holding meetings of directors and shareholders, or
· maintaining business records and transactions separate from those of the owners.

What Is an S-Corporation?
An S-corporation is a normal corporation (known as a “C” corporation) that has changed to "S corporation" tax status. An S corporation allows the same limited liability of a corporate shareholder but also allows you to pay income taxes on the same basis as a sole proprietor or a partner.

This is because in a regular C-corporation, the company itself is taxed on its business profits. In addition, the owners also then pay individual income tax only on money that they receive from the corporation as a salary. Therefore, a C-corporation is taxed twice, hence the term “double taxation.” In an S corporation on the other hand, the corporation is not taxed at all, and all business profits "pass through" to the owners, who report them on their personal tax returns. Therefore, the S-Corporation is taxed only once.

Is S Corporation Status Right for You?
Depending on certain criteria, you can elect to do business as an S corporation. Operating as an S corporation rather than a regular corporation may be the best choice for several reasons:
· An S corporation generally allows you to pass business losses through to your personal income tax return.
· Upon sale of your S corporation, your taxable gain on the sale of the business may be less than if you sold it as a regular C-corporation.
Another advantage of the S-Corporation status, is that it need not be permanent. If you later decide that there are tax advantages to being a regular corporation, you can drop your S corporation status after a certain amount of time.

Alternatives to the S Corporation
The goals of limited liability and pass-through taxation can also be achieved by forming a limited liability company (LLC). An LLC may also offers its owners greater flexibility in balancing profits and losses. Also, because LLCs aren't subject to the many restrictions of S corporations, forming an LLC may prove to be a wise option for the entrepreneur. You must however, closely examine the goals of your business venture and the activities that you will partake in to determine whether an LLC is a better alternative than a corporation. For example, if you expect to have multiple investors; expect to raise money from the public, or would like to offer stock options to key employees, then the LLC is not the alternative you want to choose, since a corporation would be better suited to such activities. Co nsult your attorney to see what business structure would be best suited to your business needs and activities.
Masood Khan is an attorney with Khan & Associates. He can be contacted via email at or at (818) 994-0347.


Editor: Akhtar M. Faruqui
2004 . All Rights Reserved.