Mistakes No Small Business Should Makes
Incorporation of a small business produces tons of great benefits. Often, the small business saves taxes by incorporation. And in almost all cases, the small business owners reduce their business risk by incorporation.
In spite of all the great benefits of small business incorporation, however, all too often small business owners find the decision to be painful and expensive because they make one or more tax mistakes. And that's too bad. One can avoid the mistakes if one knows what they are...
Incorporation Tax Mistake #1: Incorporating When an LLC Would Do Just as Well
Many small business owners don't realize that a limited liability company provides just as good of liability protection as a regular, old-style corporation. In addition, an LLC keeps the business owner's tax accounting simpler in many situations.
Accordingly, one of the most common (and sometimes most expensive) incorporation mistakes is using a regular corporation rather than a simpler, cleaner limited liability company.
The lesson here is when you're starting a new business, look closely at the LLC option. By using an LLC, you may be able to save yourself tons of aggravation.
Incorporation Tax Mistake #2: Forgetting to Pay the Owner a Salary
Small business corporations operated by the owner need to pay their owner a salary. That's the rule. But then there's the rub.
Payroll accounting takes time. Payroll taxes cost money. And, frankly, the whole employee payroll process is just an enormous headache.
Predictably, then, many small business corporations just forget or skip doing payroll for their shareholder-employees. This isn't a mistake you want to make, however. If the IRS catches up with you (and they eventually will), the corporation and the shareholder-employee will get penalized. Ouch.
Incorporation Tax Mistake #3: Forgetting to Do Quarterly Tax Deposits
Operating a small business as a regular corporation, known as a C corporation, means that the corporation itself may owe income taxes to the federal or state government. If that's the case, the corporation needs to make quarterly estimated tax payments.
Note that these quarterly payments (due April 15, June 15, September 15, and January 15) are definitely not complicated to make. The payments, however, are easy to forget...
Incorporation Tax Mistake #4: Ignoring C Corporation Tax Loopholes
Unlike sole proprietorships, partnerships and S corporations, C corporations provide some interesting and unique fringe benefit tax loopholes for shareholder-employees including gold-plated health insurance and even tax-free housing.
Any small business operating as a C corporation, therefore, should look at exploiting these congressionally sanctioned tax loopholes. The annual tax savings can easily add up to thousands of dollars.
Note: A C corporation is just a regular corporation that has not made the special election required to be treated as an S corporation. If a corporation files an annual federal 1120 tax return, the corporation is a C corporation.
Incorporation Tax Mistake #5: Not Looking at Subchapter S Corporation Status
Most corporations in the United States make an election to be treated as a Subchapter S corporation rather than accepting the default tax classification (which is C corporation tax treatment).
Which begs the question, "Why?" And here's the answer: If a small business corporation is owned by US citizens or permanent residents, the corporation can elect S corporation status and then avoid paying corporate income taxes and even minimize paying payroll taxes on shareholder-employee wages.
Some accountants and tax preparers don't like S corporations because the S corporation 1120S tax return can be a little more complicated to prepare. And this dislike can tend to affect the advice they offer their clients. But small business corporations should generally at least look at the S corporation option. The savings can amount to several thousand dollars per year per shareholder-employee. Yikes.
Incorporation Tax Mistake #6: Putting Investments Inside the Corporation
A final incorporation mistake should be mentioned. Entrepreneurs often like to store investments inside their corporations--sometimes for reasons of convenience or easy control. But storing real estate, stocks, and other investments inside a corporation creates problems and causes the business owner to bear additional tax risks.
Without going into all the nitty-gritty details, storing investment assets inside a corporation may mean paying a higher capital gains tax (even if the corporation is an S corporation). And storing investment assets inside a corporation may trigger early payment of capital gains.
The bottomline? Small business owners should typically store their investment wealth outside of their business corporations.
About the author:
Seattle tax accountant Stephen L. Nelson is the author of numerous ebooks about small business incorporation and llc formation. For more information about his CPA services, visit his website, www.stephenlnelson.com.