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The Week's Big Idea: Incorporate

Will you save on taxes if you incorporate? Today, we weigh the additional costs and time spent versus the benefit to your bank accounts. 

Will incorporating help me pay less in taxes?


Today, we'll cover the other question to ask before you incorporate: will you get a tax benefit?

Businesses and people are taxed at different rates by the IRS. 

At the federal level, businesses are taxed on their profits ONLY, meaning that wages, office supplies, travel, medical insurance, internet, etc., get paid with pre-tax dollars. That's another 12 to 37 cents you get to spend out of every dollar. It adds up!

You get to write off lots of kinds of business expenses without being incorporated. But incorporation may reduce the amount of tax you pay on your profits. As you make more money, a corporation can help you reduce the amount of personal taxes that you owe, also called your tax liability. 

So what are some of the tax benefits of being incorporated? 


Is the extra work and cost worth it?


Two key things to consider are your household income and your potential to take investors.

Household income.
If you or your partner have lot of employee income (called W-2 earnings), it’s worth doing some tax planning with your accountant or business manager. If you already make a lot of money, the profits from your business will be taxed at a high personal rate if you are a sole proprietor. 

If you make over $82,000 as a single person or $165,000 as a household, your incremental business profits above these amounts will be taxed at 24% to 37%. You may be better off paying the 21% federal corporate tax rate on your profits.

If you operate at no profit or a loss, you can decide whether to limit your exposure to those losses by keeping them in the business, or applying them to reduce your personal taxes. 

Investors. If you have partners or would like to take on investors, they may have an opinion about your tax structure. If you are planning on taking professional investors, they are likely to want all the revenue and tax liability to stay within the business.

Costs. An incorporated business has its own federal and state tax returns. You will most likely need to use an accountant. You may have to pay a base state tax no matter what - in California, it's $800 per year.

You'll need to keep more records about what you pay yourself, either as salary or owner's distribution, as well as all of your expenses. You may need to hire a bookkeeper. 

A rule of thumb on when the tax benefits outweigh the additional costs in California is roughly between $80,000 and $100,000 of gross business revenue. It may be less in your state. This topic is a great way to start a conversation with your personal team!

A little bit of planning around your expected personal income and your potential for taking investors in the first 3 to 5 years of your business will go along way in helping you choose the right corporate structure.

Today's Assignment: are you profitable?


We've talked about building a sales pipeline and using simple tools to track your expenses. Have you considered these together? If your revenue is more than your expenses, you are operating profitably. If you expect to have a profit for the year, that means your business has tax liability.

Coming up: demystifying the LLC


We love feedback! Use our Typeform or reply to this email to let us know what you enjoyed or where we can provide more support.
 

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