Incorporating

1. Double taxation is avoided 

Double taxation occurs when a corporation pays corporate income tax on its net income, and then the shareholders pay tax on any dividend income they receive from the corporation (This often occurs with C corporations). Double taxation hits particularly hard when a company is sold by way of an asset sale rather than a stock sale. 

By becoming an S corporation, profits and losses are taxed to the owners in proportion to their ownership percentages. For example, a 10% owner would pay income tax on 10% of the profits or losses at their personal tax rate.

Since profits and losses “flow through” and are taxed on the individual level, there is generally no federal income tax on the  corporation itself.  Some state taxes could still apply. The S corporation’s shareholders will generally NOT be taxed on profit distributions from the corporation as they have already paid tax on their share of the company’s profits.

2. Avoidance of self-employment tax by the shareholder of the corporation
Sole proprietors and independent contractors are subject to self-employment tax at a rate of over 15%. A self-employed person who forms an S corporation and becomes an employee of that corporation is no longer subject to self-employment tax on the net income. However, both the employee and the employer will be subject to social security and Medicare taxes. The IRS requires reasonable wages be paid to shareholders. 

(This information is designed to be of general interest.  The specific techniques and information discussed may not apply to you.  Before acting on any matter contained herein, consult with your professional advisor.)