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There are many benefits to incorporating your business. Most business owners who incorporate are seeking limited liability, and a properly formed and operated corporation is considered a separate legal "person." It is from this concept that corporations derive many of their benefits.
One of the most sought-after benefits of a corporation is that the assets of the owners are protected from business liabilities. As a separate legal entity, a corporation incurs business debt or liabilities on its own behalf, which shields the business owner from responsible for the debt. This can be especially important if the business venture is risky or for a wealthy owner. This protection is eliminated if a lender requires the corporate shareholders to guarantee corporate debts.
Incorporation also offers tax benefits to the business owners, which include health and life insurance, travel and entertainment deductions, retirement plans, educational benefits, and dependent care assistance. In some situations, items that may be only partially deductible by a proprietor become fully deductible in a corporation. When planning in this area, it is important to consider various tax requirements such as discrimination rules that require benefit plans to cover all employees.
Also, with a corporation, business owners own stock shares of the business, rather than owning the business property directly. In certain situations, this can make the transfer of ownership‹or partial ownership‹of the business easier, and can. be especially beneficial in certain family/estate planning situations.
To many people, the corporate identity inherently makes a one-person shop sound more credible. To these people, the words "corporation" or "inc." in a business name convey stability and business sophistication.
As a separate entity, the corporation will be required to obtain its own tax identification number and to file its own tax returns. Additionally, it is not proper to mix personal and corporate assets or funds together, called commingling. Commingling can cause shareholders to lose their limited liability.
The possibility of double taxation on income exists since the corporation will have to pay income tax on its earnings. Then, the shareholder may have to pay income taxes when the earnings are distributed from the corporation to the shareholder, commingling only in the form of dividends. This can often be avoided by either electing "S corporation" status or with careful planning of income and deductions.
Typically, money earned by the corporation will not be credited to your Social Security earnings. However, the salary paid to you by the corporation will be, and it will be deductible by the corporation. There are tax laws requiring reasonable compensation to be paid to shareholder/employees.
These are a few issues to consider when evaluating a corporate form of business. There are additional pros and cons, and there are other entity types that should also be considered.
Michael P. Lynch, CPA, CFP, is a sole practitioner. His e-mail address is firstname.lastname@example.org.