Should I incorporate my business? (Part Two)

Should I incorporate my business?  (continued...)

Let's continue our conversation about incorporating a small business and important reasons to consider forming a corporation.  Last time we touched on limited liability and today let's explore income tax savings and transferability.

Income Tax Savings.  From an income tax perspective, a sole proprietor pays self-employment taxes on the net profit of a business.  As the net profit from the business operations increases over time, the owner may be able to reduce the amount of self-employment taxes by incorporating as a "S" corporation and taking only a portion of the net profits as officer's salary, while treating the balance as shareholder distribution.  S corporations are pass-through entities for income tax purposes and no tax is typically paid at the corporate level.  At the end of the year, the shareholders receive a K-1 tax form showing their proportionate share of profits (or losses) which they will include on their individual 1040 tax returns each year.

Transferability.  The third aspect mentioned above, ease of transferability of ownership, is especially important where a partnership business is incorporated, or where there are two or more shareholders operating the corporation.  Frequently, the shareholders will enter into a buy-sell agreement which deals with the legal issues arising from the incapacity or death of a shareholder, or when one of more of the shareholders wishes to sell or transfer his or her interest in the corporate business.

An alternative to the corporation is the limited liability company.  These types of entities are similar to corporation in that they offer limited liability and ease of transferability of membership interests, but they generally do not offer the same income tax savings to the owners as the corporate entity.

I hope that this helps for those of you considering incorporating.  The foregoing is but a brief overview of a complex subject and the reader is cautioned to seek the advice of an experienced business attorney and their accountant before proceeding with the incorporating process.