Do you currently run your small business as a sole proprietorship and wonder whether it makes sense to incorporate? There are many potential tax advantages to forming a corporation. Here are a few to whet your tax-savings appetite.
1. Deduct all your medical expenses. You can establish a medical reimbursement plan (MRP) and deduct 100% of your out-of-pocket medical expenses. It is very difficult to deduct medical expenses on your personal tax return because you must itemize deductions on Schedule A, and you can only deduct medical expenses to the extent they exceed 10% of your gross adjusted income.
A sole proprietorship can have a medical reimbursement plan, but this only works if the owner is married and hires his/her spouse an employee of the business. Forming a C Corporation solves this problem, because the owner can be an employee of his own corporation and be covered by the medical reimbursement plan. An S Corporation can also have a MRP, but the tax savings are less than a C Corporation.
2. Deduct all your health insurance premiums. A sole proprietorship can potentially deduct health insurance, but only to the extent of business profit. If the sole proprietor has a loss, he gets no deduction for health insurance. If the sole proprietorship has a profit that is less than the health insurance premium, the deduction is limited to the amount of the profit, and the rest is lost. A C Corporation allows for premiums to be deducted regardless of the bottom line. An S Corporation can also deduct health insurance premiums on behalf of an employee-shareholder, but the tax benefits are less.
3. Reduce your self-employment tax. The sole proprietor is plagued by the dreaded self-employment tax. An S Corporation may provide the opportunity to legally reduce this tax by having a portion of profit reported on Schedule K-1, where it is subject to personal income tax but not self-employment tax. Of course, the S Corp owner must still receive reasonable compensation as an employee of the corporation, and these W-2 wages are subject to payroll taxes, which are the equivalent to the self-employment tax. But if the fair market value of the owner’s employee wages is less than the corporation’s profit, this is an appropriate strategy to reduce self-employment taxes.
4. Tax-free fringe benefits. There is a long list of employee benefits which are available to corporation employees. These benefits include the following: education assistance, employee-provided vehicle, de minimis fringe benefits such as holiday gifts and other occasional employee perks, dependant care assistance, on-premises athletic facilities, retirement planning services, life insurance, and employee discounts.