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Why Incorporate?

Liability Protection
Liability is unlimited as a sole proprietor. Your home, personal bank accounts and other assets are at risk. Incorporating your business separates your personal and business assets and protects you from risks and liability.

Tax Savings
As a sole proprietor, you are required to pay a self-employment tax of 15.3%. If you operate as a S-Corporation, you only pay self-employment tax on salary and not dividends. This can cut your tax bill by 50% or more.

Reduced Chances of Tax Audit
The IRS audits sole proprietor businesses at a higher rate than S-Corporations. The reason for this is that the IRS finds more errors in sole proprietor returns.

S-Corporation or LLC?

Are you confused as to whether you should incorporate as an S-Corporation or form an LLC? Below are some advantages with each entity:

S-Corporation
  • Personal liability protection
  • Taxed at corporate and individual level
  • Easier to convert to a C-Corporation as the company grows
  • Reduced chances of tax audit
  • Easier to effectively grant equity
LLC
  • Same liability protection as a corporation
  • No corporate tax, profits passed directly to owners
  • Fewer corporate formalities required
  • Ability to issue different classes of securities
  • Available to non-US investors
For the most part, the dynamics of an S-Corporation and LLC are similar in respect to liability and day-to-day operations. An S-Corporation does require a bit more formality in the form of a few required corporate meetings and minutes each year.

But the S-Corporation's HUGE advantage over an LLC is its ability to pay compensation to its owner(s) through dividend payouts. Let's look at the following example to help illustrate this advantage:

Larry is the sole owner of his computer repair business. Larry's business generates $100,000/year in revenue. As an LLC, Larry would have all of the company's profits pass to him as an individual and he would be responsible for paying the 15.3% self-employment tax on his $100,000 in earnings. That corresponds to $15,300 paid for self-employment tax.

Now if Larry operated as an S-Corporation, Larry could elect to pay himself an annual salary of $40,000/year and have the remainder $60,000 paid in dividends. (It should be noted that the salary established should be a fair-market salary, according to the IRS). Now, Larry is only required to pay $6,120 in self-employment taxes on his $40,000 salary while the $60,000 dividend payout is exempt from self-employment taxes. The savings in self-employment tax avoidance alone is $9,180.

In Summary
Based on self-employment tax savings alone, the S-Corporation election is the superior choice for any small business with less than 50 employees. It's no wonder that, according to the IRS, S-Corporations have been the most popular tax-filing entity in the U.S. since 1997.


 
 
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