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Brought up Mar 19, 2010

The benefits of incorporating and what it means to you and your company.

My Fiancé and I are becoming a company tonight. This is perhaps more legally binding than our pending marriage, but a smart financial move. I don’t recommend incorporating with someone you don’t intend to have a long relationship with. I have been dutifully researching the process and the benefits of incorporating and thought I should share what I have learned with my readers.

Why become a corporation?

Incorporating isn’t really important unless you are making an income of over six hundred dollars a year through a personal business. For example my Fiancé is a paid actor, director, and sound designer. (I am a lucky girl) I am a freelance writer, as you know I gain a small income through my story sales and through my ads. Because our total income from these projects is over six hundred dollars a year the income from said projects will be taxed. The tax rate on “Other income” as you may know is huge. So to keep more money in our pockets we have decided to become, Blue Collar Black Tie, Inc. Besides the tax reasons, corporations also serve to protect the shareholders of the company against litigation. Let’s say for example my Fiancé is working at a theater setting up sound design. In the process he spills a large cup of coffee on the mixing board. The theater might choose to sue him for the costs! Since we are incorporated they would actually be suing our company. The litigation could bankrupt our company, but my soon to be husband and I will not lose our personal savings.

How does being a corporation shelter you from tax?

A corporation is only taxed on the money it makes in a given year. Expenses are not taxed. So let’s say Blue Collar Black Tie Inc. starts the financial year with 6,000 dollars in its coffers. Then because the company needs a fancy computer, a top of the line IMac is purchased. 3,000 dollars is deducted from the coffers. The total income of the company is: negative 3,000 dollars. In order for the company to be taxed at the end of the year, Blue Collar Black Tie, Inc. will have to earn over 3,000 dollars. If that does not happen Blue Collar Black Tie, Inc. may be a “failing” company, however, no taxes on that year’s earnings will be due. The end result is that my fiancé and I have a couple hundred more dollars to keep our company running.

This is why there are so many huge corporations out there that rarely make a profit, yet continue to exist. You don’t have to be profitable to be a company!

What is an S Corporation?

The important defining characteristic of the S corporation to you, is how the IRS allows funds to be distributed to stock holders. This structure is allowed by the IRS to pay the shareholders by means of a non-dividend distribution tax free, so long as the distribution (payment) does not exceed the total value of the stock the share holder owns. What does that mean?!? Basically should your company make a profit, you can distribute funds to (pay) the shareholder (you) so long as you don’t distribute more funds to the shareholders than what the company earned that tax year. This means that the IRS only taxes the profits of the company once, while in a C Corporation the IRS would tax the profits twice, once as the company’s total profits and then again when the profits are distributed.

That being said, the best way to pay yourself through the corporation is to higher yourself as an employee of the corporation and cut yourself a actual paycheck. Remember federal taxes, state taxes, Medicare, unemployment insurance will need to come out of this check just like they do from your current employer. While this may seem overwhelming it is simpler than it appears, and will be discussed in future articles.

Some drawbacks to incorporating

If you withdrawal $2,000 from your corporation's coffers to install a spa in your back yard it is called embezzlement. The money you earn from your side projects is not instantaneously your own, it belongs to the company and can only be spent for personal reasons after the profits have been distributed to you as a shareholder or through salary. So if you are not serious about growing a company for the long term, incorporating might not be for you. Also, in order to run a corporation you will have to take the time to set up filing systems, and keep records of all the money flowing into and out of the corporation.

Naturally I am not a tax attorney and corporation laws vary from state to state, so make sure to do your own research.


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