LearnAboutLaw Staff July 2007
Owners of businesses often inquire as to whether organizing as a Corporation offers any tax benefits. The following are some ideas on how a Corporation can be organized in a manner that gives a net tax savings. As with any taxation or legal issue, you should seek professional guidance before putting in place any of the ideas set forth here.
• Dividends and Profits Are Taxed at a Lower Rate Than Salaries. Corporations can pay their owners partially–and the keyword is “partially”–in dividends (profit distributions) rather than ordinary income. Dividends are taxed at a maximum rate of 15%, thanks to tax law changes put in place in 2003. Income, on the other hand is taxed at a maximum rate of 35%. A corporation owner can take some of his or her company’s profit in dividends rather than a salary, thereby reducing his or her tax burden. But the IRS is wise to the device, so you must check with your accountant first though, and you must pay yourself a reasonable salary before being too generous with the dividends. For further detail, read Use S-Corp Dividends and LLC Dividends to Minimize Taxes.
• Dividends and Profits Are Not Subject to FICA . Furthermore, dividend and/or profit distributions are not subject to 15% Social Security and Medicare taxes as salaries are. Again, the same warnings apply.
• Shift Personal Income into a C-Corporation . A C-Corporation pays only 15% on its first $50,000 of annual income. An individual, however, pays 25% to 38% on his or her personal income over $31,851, as well as 15% for FICA (2007 rates). And so, a C-Corporation owner in a high tax bracket can shift his or her first $50,000 of income into the C-Corporation, and can enjoy a significantly lower tax rate on that $50,000 of income. This works best in states with low income taxes. An accountant can help you calculate your tax savings accurately.
• Better Deductions for Losses . Corporations are not burdened by severe restrictions on operating and capital losses. Generally, losses can carry back 3 years, and can carry forward up to 15 years.
• Fewer Audits . Exact figures are disputed, but it is clear that the IRS conducts fewer audits on LLCs and corporations than it does on individuals.
• Medical Insurance . Corporations enjoy greater tax deductions for medical insurance premiums paid for an owner-employee. Individuals can only deduct 60% of the premiums, while a corporation can deduct 100% of the premiums.
• Higher 401K Deductions. Through a corporation or LLC, individuals can make higher contributions to 401K plans. Savings may be doubled with a corporate or LLC matching plan.
For information on the tax advantages of LLCs, read LLC Tax Advantages – LLC Advantages.