Employment

Friday, August 20, 2010

Go Into Business for Yourself, Not the Tax Man

by Richard Barrington, VendorSeek.com


With unemployment rising, some people find their best option is to go into business for themselves. Thanks to today's technology and business practices, this has never been easier, and could represent a great opportunity. However, when you set up a modern, cutting-edge business, you need to take one old-time concern into account: taxes.

The corporate structure you choose when you set up a business can affect your personal and tax liability. Therefore, before you go into business, it is a good idea to have a conversation with a corporate tax specialist about some of the key issues that can affect which corporate structure is right for your business.

Setting up Shop

When it comes to setting up a new business, you may have everything you need at your fingertips. Anyone with business experience has had a chance to learn some of the keys to running a successful operation, and may also have an insight or two about what to do differently. Web design specialists and e-commerce solutions providers can set you up with a place of business on the Internet much more cheaply and easily than it would cost to rent office space. Credit card processing contractors can expedite the handling of receivables for you, and equipment leasing can lower the barrier to give you the physical tools your operation needs.

It's all so straightforward that it might be tempting to keep it simple and operate as a sole proprietorship. However, there are good reasons to consider a more formal corporate structure. Which kind of formal structure? That depends on the following issues:

1. Liability. Perhaps the foremost reason for setting up a formal corporate structure is to shield yourself from personal liability. If you don't feel your business practices could incur any liability, by all means operate as a sole proprietorship. In most cases though, you may find it better to have a separate corporate entity take on the liability for business operations.

2. Corporate procedures. While setting up a corporation can reduce your personal liability, it only works if you respect that corporation as a separate entity. You have to be willing to follow formal corporate procedures, and not simply treat the business as an extension of your personal affairs.

3. Property and equipment leasing opportunities. While you need to respect the separation between yourself and the corporate entity, that doesn't mean there can't be any dealings between the two. You may have the opportunity to lease property or equipment to the business, or even charge for services like Web design. The idea is to shift tax responsibility between you and the corporation according to which is more favorable. However, any such dealings have to be on terms that would make sense for an arm's length transaction.

4. Personal tax vs. corporate tax. The idea of shifting tax responsibility is based on one of the most fundamental benefits of a corporate structure. There are often differences between personal and corporate tax rates and accounting procedures. For example, corporate tax rates are often lower than personal tax rates. However, the commonly-used C-corporation structure can expose earnings to double taxation -- once at the corporate level and then again when earnings are distributed to shareholders.

5. Company growth rate. Structures such as limited liability companies and S-corporations are able to avoid double taxation by passing the tax liability directly through to the owners of the company. However, a fast-growing company that anticipates needing capital in the future may want to retain earnings for that purpose. In that case, a C-corporation structure may be better, because the tax rate on earnings is likely to be lower at the corporate level, and if earnings aren't distributed immediately, double-taxation can be avoided or postponed.

6. Company size. Regarding the S-corporation vs. C-corporation issue, size may be the deciding factor because S-corporations are limited to 75 shareholders.

7. Benefit plans. An important tax advantage of incorporation is the treatment of health and retirement benefits. Compared to an individual, a corporation may be able to deduct health insurance more readily and defer taxes on a larger amount of retirement savings.

8. State income tax. State taxes can vary for different corporate structures, so this is a location-specific factor you need to take into consideration.

Making the Choice

As the above issues suggest, the right choice of corporate structure for tax and other purposes is very much a function of conditions specific to your business. That's why there is no pat answer to the question of what is the "best" corporate structure, but knowing what the relevant issues are can help you find the best answer for your specific situation.


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