In past issues we discussed some myths about incorporating. This will elaborate and expand on some of the subject matter discussed.
There are two main reasons why you should incorporate your business. One is to save on income and social security taxes and the other is to protect assets. How can you save money on your income and social security taxes and take enough money out of the business to live? This can be accomplished by becoming an S-Corporation. As an S-Corporation owner-employee, you must take a salary and report the employment taxes. This leads to some additional paperwork. In addition to your salary, you can take money from an S-Corporation by receiving a shareholder distribution. The money received as a shareholder distribution is not subject to employment taxes but ultimately is subject to income taxes.
A frequently asked question is, "Since all the income of the S-Corporation is taxable through the owner-employee, how much of it must be taken as salary?" The salary that you are taking must be reasonable for the amount and quality of services that you provide to the corporation. You can decide this by looking at what others in the industry earn. If you decide not to take a salary and take only distributions from your corporation, the IRS can call the distribution "dividends," (possibly terminating the S-Corporation election) and impose taxes at both the corporate and shareholder level. Remember that the determination of a reasonable salary is complicated. Your personal tax advisor should do the computation.
To recap, the tax savings that one will realize (by incorporating and becoming an S-Corporation) are achieved by taking a proper mix of the income that the corporation earns in the form of salary and distribution. The salary portion is subject to social security taxes; the distribution is not.
If you choose to become a C-Corporation, there are benefits that the S-Corporation does not have. These benefits are in the area of "employee benefits." They are medical reimbursement plans, medical insurance, disability and group life insurance, pension, and profit sharing plan possibilities.
Since we have discussed saving taxes as one of the major reasons for incorporating, how do you know you are earning enough income to make it pay for you? Or, how much tax money will you save by incorporating as an S-Corporation to offset the increased costs but yet have enough money left over to make it worthwhile? Your tax advisor can do the tax projections necessary to make that determination. The projection must be directed at the level and the consistency of your profits as well as the ability to maintain that profit. When you have your bookkeeping done on a regular basis, your tax advisor can determine from the operating statement if it seems advisable to incorporate.
But beware! Recently, many truckers have made the mistake of incorporating their businesses without proper tax and legal guidance. Operating as a corporation can be very costly. There are many additional fees of which most people are not aware. For example, there is an additional tax return to be prepared and filed each year. Additionally, when you incorporate, you become an employee of the corporation with strict payroll requirements. If you are unable to calculate your own payroll and keep up with payroll tax deposits and quarterly payroll tax return filings, you will have to hire a payroll service or an accountant to do it for you. Corporations also have increased bookkeeping requirements that most owner-operators will not be able to handle on their own. Even a bookkeeping service must adhere to the increased requirements of maintaining a corporation's general ledger.
In many cases incorporating is advantageous from a tax, legal and asset protection standpoint. Be aware of all the implications before you incorporate. Seek the advice of your tax preparer and attorney to be sure the advantages are going to be well worth the extra time, effort and cost.
This article has been presented by PBS Tax & Bookkeeping Service, a company that has been providing income tax and bookkeeping services to the trucking industry for more than a quarter century. Contributions to this article were made by Shasta May, director of business development for PBS. If you would like further information, please contact Barry or Howard at 800-697-5153. See our website at www.pbstax.com.