Form Your
Own Corporation and Save Money in Taxes
By Masood Khan
CA
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 mkhanlaw@aol.com
or at (818) 994-0347.
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