Business Entities

GIMME A TAX BREAK

WHAT FORM OF ENTITY SHOULD A TAXPAYER USE FOR THEIR BUSINESS?

The vast majority of small businesses are operated by individuals as self-employed persons. As such, you are required to file schedule “C” and part of your personal form 1040. You must also include a schedule SE for the self-employed tax or social security tax.

In many cases the self-employed person is smart to stay as a sole proprietor filing schedule “C”. However, you need to realize we live in a very litigious society. Therefore, if you make a product or provide some form of services, you might then consider incorporating your business.

If you are not a professional corporation (such as an attorney, architect, dentist, doctor or CPA) you can put a layer of protection between yourselves and your clients by operating as a corporation. That means if the service is unsatisfactory or the product sold is defective and you cannot resolve the issue for the client or customer without going to court, then any suit filed by the client or customer will be against the corporation and not you, the owner. Obviously, every rule has exceptions and in this case if you commit a malicious tort action you can be sued personally.

Like all good options; the election to operate as a corporation has some cost involved. First, in California there is a minimum annual tax of $800 each year for a corporation doing business in the State even if it shows little or no profit. Second, you need to pay a CPA or other professional to file the annual income tax returns.

If you elect to form a corporation you can then elect to be taxed as a “C” corporation which means all of the profits after owners’ salaries are taxed in the corporation. Then, if you draw out dividends, they are taxed at 15% currently for federal purposes and at whatever bracket you are in for the state.

However, you can elect “sub-Chapter S” status and have all of the profits flow through for tax reporting purposes to the shareholders. But remember, you still pay the state a minimum $800 corporate tax or 1.5% of the profits, whichever is greater.

8/23/07