ARE 80% OF ENTREPRENEURS WRONG?
About 80% of America's small businesses are
unincorporated, according to government statistics.
Many of these businesses could reduce their income tax
bills by incorporating, because the corporation is
still America's best small-business tax shelter.
Let's look at a small retail business that is
jointly owned by a husband and wife. The business has
gross sales of over $415,000 and a net income of about
$48,800. The owners also earn about $4,000 in interest
and $1,200 in dividends.
Out of this, they have to pay self-employment tax
of about $6,900. They also pay medical expenses of
almost $10,000. Because they can deduct only medical
expenses that exceed 7.5% of their adjusted gross
income, $6,300 of their medical outlay is included in
their itemized deductions. Their federal income taxes
are about $3,800.
Now suppose they incorporate the business. The
first thing the corporation lets them do is establish a
medical-expense reimbursement plan under which the
corporation pays their medical expenses. The payments
are tax-free to the owners and deductible by the
corporation.
Other expenditures, such as automobile purchases,
could also be paid for by the corporation. The value
of the vehicles would have to be included in the
owners' gross income, but the expenses would be
deductible by the corporation -- and it is cheaper to
include them in gross income than to pay for them with
after-tax income.
The owners draw salaries from the corporation, but
they will not need to draw the $48,800 they are netting
as proprietors, because the medical and other expenses
are paid by the corporation. By taking salaries
totaling about $35,000, they eliminate $2,110 in Social
Security self-employment taxes. The standard deduction
and personal exemptions cut their taxable income to
$22,850. Their federal income taxes for the year are
$3,428. Total tax savings from incorporating so far
are about $2,500.
Eventually, they can have the corporation set up a
pension fund and other benefit programs for them. They
can also get more tax-advantaged cash out of the
corporation by buying business assets themselves and
leasing them to the corporation. The corporation's
taxable income up to $50,000 is taxed at its 15% rate,
but most small corporations can keep the taxable income
around zero.
