The Art of Business: Is It Time to “Incorporate”?

CreativePro Staff

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Did you hear the one about the artist who became an accountant? Probably not, because it’s a preposterous idea. Artists (and writers) are notoriously bad with all things financial. If you can relate, you may still be toiling away as a sole proprietor (and paying all that self-employment tax) or locked inside a business entity that isn’t doing you any favors.

The answer may be incorporation. Incorporating has become easier and cheaper than ever, and a plethora of how-to books can, if nothing more, help you educate yourself before you take the recommended approach of contacting an accountant or tax attorney. Take a look at "How to Incorporate: A Handbook for Entrepreneurs and Professionals," by Michael R. Diamond, and Julie L. Williams or (you got to love the title) "Own Your Own Corporation: Why the Rich Own Their Own Companies and Everyone Else Works for Them," by Garret Sutton, Robert T. Kiyosaki, and Ann Blackman.

Why Incorporate?
Incorporation has a number of benefits. When you incorporate, you create a business that is legally a separate entity from you, shielding you and your partners from any personal liability for business debts and obligations. That’s not to say, of course, you can partake in illegal or fraudulent acts, for which you can still be held liable.

Incorporation is also great if you ever think you may want to sell your business. A corporation does not depend on the lives of its members. So the corporation will continue to operate even if you decide to sell your interests.

But most creative professionals consider incorporation because of its attractive tax benefits, according to Bruce Arnold, a CPA with Robinson Rabinowitz & Bernstein in Atlanta.

If the incorporation structure is right and your income is high enough, you can save thousands of dollars annually, according to Arnold.
What Do You Have to Do?
The first important step if figuring out what type of corporation is best for you. There are several to choose from:

• General corporation. This is the most common legal structure for large entities. It is a legal entity owned by an unlimited number of stockholders who are personally shielded from debts or obligations related to the business.
• Close corporation. A close corporation has a small number of shareholders, ranging from 30 to 50, no ready market for the corporation’s stock, and active participation by the majority of shareholders in the management of the corporation.
• Limited liability company (LLC). An LLC is a business entity formed upon filing articles of organization with the proper state authorities. LLCs generally provide limited liability and are taxed like a partnership, preventing double taxation.
• S corporation. This type of corporation provides the benefits of incorporation, but it eliminates "double taxation," which happens when the profits of a corporation are taxed first as income to the corporation and then second as income to the shareholders when profits are distributed as dividends. An S corporation is limited to 75 or fewer shareholders.

Many professionals just getting started select the S corporation because of its attractive tax and financial benefits, according to Arnold.

“S corporation combines the best of both worlds. It offers the business and tax advantages of the more formal C corporation with the flexibility and ease of set-up of an LLC, partnership, or sole proprietorship,” said Arnold. For example:

Income from an S corporation is taxed at only one level rather than two. “The federal government doesn’t consider an S corporation a taxable entity. That means that income is passed directly through the corporation to the shareholders,” said Arnold. Simply put, you won’t pay corporate taxes and then personal taxes on the same income.

You can write off operating losses during the first few years. This benefit alone makes an S corporation a great choice for professionals just starting out or contemplating major expansion. Just don’t expect the Internal Revenue Service to accept carte blanche losses just because you are incorporated. Your losses should roughly match the amount you invested into the corporation either through direct investment or direct loans, according to Arnold.

An S corporation allows you to offer yourself tax-deductible benefits. One you’re set up as an S corporation, you can offer health and life insurance benefits to you and your employees, as well as deduct travel and entertainment expenses. Plus, you can set up retirement plans that allow you to save more than you could as a sole proprietor.

Your decision to elect to be an S corporation isn’t permanent. If you later find there are tax advantages to being a regular corporation, you can easily drop your S corporation status. Just remember that if you make a change in the middle of a tax year, you’ll have to file two tax returns — one for each corporate entity.

Income from an S corporation can be taken as dividends. Tired of paying all that self-employment tax? You don’t have to. The regulations state that you must take a "reasonable" salary from your corporation, but beyond that you can bypass the 15.3 percent self-employment tax by taking some of the profits as dividends from the corporation.

Next Steps
You begin the process by filing articles of incorporation with the proper state authority. You must also complete, but not file, corporate bylaws, which state the rules that govern corporate life under state law.

You don’t legally need an attorney to incorporate, but despite what self-help books say, why skip it? An attorney will help you make the proper selection and ensure all your “t’s” are crossed. Just the piece of mind may be worth the attorney’s fee.

Is it worth all the hassle? Figure it this way. How much time and effort would you put into a job that pays $5,000? A week, maybe two, maybe even three?

So what’s stopping you from investing even less time in a project that can save you $5,000 per year for years to come?

Read more by Eric J. Adams.