tax standpoint, there are both advantages anddisadvantages to incorporating. Yes, forming a corporation caneither reduce your taxes or increase your taxes, depending onwhat type of corporation you create.
There are two main types of corporations: "C" Corporations and"S" Corporations -- and which type you choose can make all thedifference in the world of taxes.
NOTE: The question of "C" Corp vs. "S" Corp has no effect on theasset protection provided by your corporation. This is a taxissue, not a legal issue.
A "C" Corporation can lead you into a Tax Trap known as "doubletaxation". Yes, income from a "C" Corporation can actually betaxed twice -- once when it's earned on the corporate level andagain when it's paid to you, the shareholder, in dividends.
There are several ways to avoid double taxation. Often theeasiest way is to tell the IRS that you choose to be an "S" Corpinstead of a "C" Corp. The profits of an "S" Corp are nottaxable to the corporation; instead, those profits are reporteddirectly on the shareholder's personal income tax return and aretherefore only taxed once.
And once is enough, don't you think!
Of course, any article on Choice of Entity must contain the olddisclaimer, "Consult your tax professional" -- I am notprescribing a one-size-fits-all approach to this issue. But formany small biz owners and self-employed folks, the "S"Corporation is a good fit because it provides protection frompersonal liability and avoids the nasty tax trap of doubletaxation -- two great benefits worth checking into.
Should you incoporate your sole proprietorship and then decidethat the "S" Corporation is the right fit, you must inform theIRS that your corporation is choosing "S" Corporation status byfiling Form 2553, which is, in effect, an application to becomean "S" Corporation.
IMPORTANT:
If you incorporate and do not file Form 2553, you areautomatically considered to be a "C" Corporation by the IRS. Inother words, to be a "C" Corporation, you just incorporate;there is nothing you have to do to inform the IRS you want to bea "C" Corporation.
There are critical rules regarding how and when to file Form2553, so be sure to read the instructions carefully, or checkwith your tax pro.
Failure to file Form 2553 on time or filing Form 2553incorrectly results in a rejection of your corporation's "S"Corp application, and the corporation is then by default treatedas a "C" Corp, subject to double taxation, the very trap youwere trying to avoid.
To download a copy of Form 2553, go to: http://www.irs.gov/pub/irs-pdf/f2553.pdf
The instructions for filing Form 2553 are found here: http://www.irs.gov/pub/irs-pdf/i2553.pdf
About the author:Wayne M. Davies is author of 3 tax-slashing eBooks for smallbusiness owners and the self-employed. For a free copy ofWayne's 25-page report, "How To Instantly Double YourDeductions" visit http://www.YouSaveOnTaxes.com
