The Benefits of Incorporating Your Business

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By, Brian Liu, Esq., CEO & Co-Founder,

As the tax season draws to a close and many lament their generous yet grudging contributions to Uncle Sam, it is the perfect time for small business owners to start planning for next year. One of the most overlooked, yet most beneficial, ways to help save on taxes is to form a corporation.

There is one thing that General Motors, Microsoft, AT&T and all other major businesses in America have in common - they are corporations. A corporation is a separate legal entity, which functions just like an individual, but with some compelling advantages:

  • Protection from Personal LiabilityAs many of you may know, incorporating is one of the best ways to protect a business owner from personal liability. Shareholders of a corporation are generally not liable for the obligations of the corporation. Creditors of a corporation may seek payment from the assets of a corporation, but not the assets of the shareholders. This means that business owners may engage in business without risking their homes or other personal property.
  • Self-Employment Tax SavingsCorporate profits are not subject to Social Security, Medicare, Workers Compensation and other taxes - a combined 15.3% in taxes. An individual proprietor would need to pay all of the foregoing taxes (commonly referred to as “self-employment taxes”) on all income earned by the business. With a corporation, only salaries are subject to these taxes.For example, if a sole proprietor earned $60,000 from the business, a 15.3% tax would have to be paid on $60,000. Let's assume that the owner of a corporation pays himself or herself $40,000 a year in salary, and $20,000 is left over as corporate profits. In this case, the 15.3% tax would only be paid on the salary ($40,000). This saves the owner of the corporation over $6,000 per year!Please note that a stockholder-employee must pay himself or herself a reasonable salary, or else the IRS could re-characterize some or all of the corporate profits as salary.
  • 15% Tax on Corporate ProfitsC-corporations provide even greater tax flexibility. By simply dividing income between the corporation and the shareholders, businesses can save thousands of dollars each year on taxes. For the 2001 tax year, after the first $27,500, personal rates are 27% and increase based on income up to 38.6%. In addition, individuals must pay Social Security taxes (12.4%), Medicare taxes (2.9%) and, in many cases, state and local income taxes. With a C-corporation, the first $50,000 is taxed at 15% -- plus, there are no Social Security or Medicare taxes. And if you incorporate in a tax-free state like Nevada or Delaware, there are no state income taxes. Therefore, if you are in the 28% tax bracket and shift $50,000 of your personal income into a corporation, you could save about $14,000 per year! (This amount includes the money saved by not paying social security and Medicare taxes).How do you avoid the double taxation associated with C-corporations? Never distribute dividends directly to the shareholders, or simply pay out dividends in the form of a bonus. Since most corporations are not limited to any particular business activity, corporate profits can be re-invested in other business ventures. Corporate profits can also be spent on employee perks.
  • Ability to Deduct Business Operating LossesCorporations have very few restrictions on operating and capital losses. Losses are generally carried back three years and can be carried forward for 15 years. Sole proprietorships not only have stricter rules, but also are subject to a higher probability of audit if there are losses.
  • Fringe Benefits and Medical InsuranceRetirement: Retirement plans can be set up through a corporation that would allow you to exclude a higher amount of income than a regular IRA. With a corporate entity, savings may also be doubled with a corporate matching program. Medical Insurance: Corporations can deduct 100% of the health insurance premiums paid on behalf of an owner-employee. As a sole proprietor filing an individual return, only 60% of the medical premium is currently deductible.Fringe Benefits and Deductions: With proper structuring, a corporation may deduct other expenses such as automobile insurance, education benefits and life insurance. These expenses are subject to strict limitations for sole proprietors (if deductible at all). Moreover, these expenses can be "red flags" that trigger audits for individuals. For example, an individual proprietor who wants to deduct expenses from a home office can trigger IRS scrutiny.
  • Lower Chance of an IRS AuditOn a percentage basis, the IRS conducts fewer audits on corporations than individuals. Corporate returns also have fewer "red flags" than individual returns. Overall, incorporating is one of the best ways a business owner has to protect his or her personal assets, while saving thousands of dollars in taxes. Since individual situations differ, I always recommend that before incorporating a business, check with your tax advisor or attorney.


Co-founded by attorney Robert Shapiro, ( takes the hassle and expense out of preparing common legal documents: LLC Formations, Incorporations, Wills, Living Wills, Prenuptial Agreements, Living Trusts, Divorces, Trademarks and Copyrights. By making the preparation of legal documents affordable, accessible online and extremely easy to use (answer a few questions and guided by self-help menus), LegalZoom has opened up the door for those who have not had the money or time to prepare important documents.

Please be advised that LegalZoom is not a law firm and does not render legal, accounting or other professional advice. The examples above are illustrations only and may not apply to each situation. Please consult a qualified tax or legal professional to discuss your individual circumstances and to maximize your tax benefits.

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