Another April 15 (or April 18 this year) has come and gone, and you’ve dutifully sent in your tax forms for one more year.
If you’re self-employed operating as a sole proprietor, tax time can be yet another reminder that you haven’t addressed your business structure yet. Maybe you started your business as a side project, and a sole proprietorship made sense. But now, filling out that Schedule SE and paying all those self-employment taxes make you cringe. And maybe your tax advisor has mentioned that you could reduce your taxes by forming an S Corporation.
The end of tax time is a perfect time to reassess what’s next for your business. Is it time to take that next step and create a legal structure? Here are some things to consider:
Are you looking to lower your payroll taxes (self-employment taxes)?
The S Corporation can help business owners reduce their self-employment or Social Security/Medicare taxes. As an S Corporation, you’re able to split your profits into two payment types: salary and S Corp distributions. You pay Social Security/Medicare tax (i.e. 15.3 percent) only on the salary portion. Meaning, if your business made $100,000 in profit and you pay yourself $50,000 in salary (and then $50,000 in distributions), you’ll only need to pay the Social Security tax on the first $50,000.
Of course, you can’t just go ahead and pay yourself $5,000 in salary and $95,000 in distribution. The IRS looks for “reasonable compensation” for any shareholder who is employed by the business. And they do watch this closely. This means you need to make sure you’re paying yourself market rate for the services you provide to the S Corporation.
Bear in mind that every business has a unique financial situation and it’s always wise to consult with a tax advisor or CPA on your own situation.
Do you want to protect your personal assets?
Without incorporating your business or forming a Limited Liability Company (LLC), your own personal savings and property are at risk to settle any debts of the business. Once your business is an S Corporation, C Corporation or LLC, it becomes a separate legal entity. This means that the corporation or LLC (and not you) is responsible for all of its debts and liabilities.
I know you don’t anticipate angering clients or defaulting on any payments. And most likely, you’ll never encounter this kind of trouble. But things do happen. A legal business structure gives you peace of mind that your retirement savings won’t be wiped out by your business venture. And since creditor judgments can actually last a total of 22 years, forming an LLC or corporation can protect the assets you’ll have in the future, not just what you own today.
When’s the right time to incorporate?
Your corporation’s “start date” is not retroactive. Any tax benefits you might receive apply from the date you incorporated. If your corporation receives a filing date of April 30, 2011, you’ll still be required to file your taxes as a sole proprietor for the first few months of the year up till April 30, 2011; then you’ll file a corporate tax return for the remainder of the year.
However, if you’re concerned about liability protection or your CPA is advising you to incorporate, there’s simply no reason to wait. Now’s a great time to invest a little effort in getting your legal structure squared away and your business set for many tax days to come.