This guest post is part of a two part series written by Kelly Phillips Erb, a tax attorney who blogs for b5media at taxgirl.com. You can find out more about Kelly here. For more information about tax and blogging, check out her handy list of prior articles on the subject including Problogger articles!
“Should I incorporate to save taxes?”
I get this question a lot over at taxgirl.com – and most of the time, it comes from bloggers and freelancers. It’s understandable. We hear all of the time how corporate tax rates are ridiculously low and individual taxpayers pay at higher rates – this tends to be true in most countries. And, in the US, the self-employed are also hit with a self-employed tax of about 15% on top of income tax. Add in penalties for not making estimated payments and tax time can be quite painful for the self-employed.
It would follow, then, that incorporating just to save on taxes makes sense, right?
Unfortunately, no. What often gets left out of these discussions is that the corporate tax is a tax on corporate profits – but that doesn’t replace an individual tax. Money that you take out of the corporation in the form of dividends and/or salary will be taxed on your personal income tax return. Translation? You’re likely not saving money in most cases.
That doesn’t mean that there are no advantages to incorporating as a freelancer – there are. It just means that the tax advantages, with few exceptions, tend to be rather insignificant for folks who are self-employed.
You don’t want the “tax tail to wag the dog” when making this important decision. Put the tax consequences aside for a moment and consider exactly what you hope to accomplish and what your individual needs are. What is it that you want to get out of incorporation? We’ve already established that, with respect to blogging and freelancing as an individual, incorporation may not save you tax dollars. Is there something else that you’re looking for?
Here are some quick reasons to consider incorporation:
1. Credibility
Yeah, it sounds weird but it’s true. Some corporations will take you more seriously when you’re “Crazy Dog Productions, LLC” than when you are “Kelly Phillips Erb, tax blogger.” This may not be the case for networks – like my own b5media – since networks tend to hire a writer, not a company. But it can be true when working with affiliate programs and other companies. One big ISP that I know of, for example, will not, as a policy, issue a 1099 to an individual; they only hire incorporated entities.
2. Health Insurance
Here’s a fact that many people don’t know: for most insurance companies, individual rates are more expensive than corporate rates. Additionally, corporate groups are not generally subject to individual physicals for the purpose of determining coverage. As a bona fide corporation (you will have to produce documentation), you may be entitled to receive a corporate rate so long as you have a “group” – with most insurance companies, two or more employees constitute a group. This is why writing co-ops are so popular.
3. Liability Protection
The idea of protecting personal assets from liability is an increasingly important issue for bloggers. Don’t be fooled: incorporating doesn’t mean that you can do, promore or write anything that you want and escape liability. But incorporation – again, as a bona fide corporation – can protect your personal assets from attachment from some kinds of judgments. The amount of protection afforded and the level of protection vary from state to state according to the type of entity. As a general rule, however, most corporations allow for some protection from liability so long as you follow corporate formalities.
4. Because it looks good
Oh come on, you were thinking that, right? Having your own company kind of announces to the world that you’ve arrived. It says that you’re serious, that writing is not your hobby, but your career. You are your business. And it looks good on a business card… There’s nothing wrong with that!
There are other reasons that incorporation might make sense – savings on self-employment taxes comes to mind and are referenced in part two of this series. However, some of those reasons require a level of scrutiny into your finances, your current tax situation and your plans for the future that can’t be had on a blog post. I would highly encourage you to have this conversation with your legal or tax professional to get the best advice for your personal situation.
But keep things in perspective. Evaluate the reasons why you might want to incorporate your business – and make sure that you’re ready to treat it as a business. Arm yourself with the facts and consult with the right folks. While it’s easy enough to incorporate, most corporate entities fold within the first two years of business – don’t become one of those statistics.
Check back tomorrow for part two of the series to find out more about popular forms of business entities.
Like any good lawyer, I need to add a disclaimer: Unfortunately, it is impossible to give comprehensive tax advice over the internet, no matter how well researched or written. Before relying on any information given on this site, contact a tax professional to discuss your particular situation. If you have a question, ask the taxgirl.
Incorporating also saves your from losing everything, because the corporation is a person in itself… otherwise you can be personally held responsible, along with all of your assets.
I think I would only incorporate if I was making a large sum of money or sell a physical product, personally. Because it looks good is a great reason though… hehe.
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Darren, I just go an error submitting this comment… here it goes again.
So you’re drawing a distinction between being a “corporation” and being a LLC (“Limited Liability Company”–which has different rules and issues than a corporation?) I signed up as an LLC, applied for a business license, registered my trademark and all that good stuff this year and it’s been wonderful. I’m not a corporation at all but I am a company and am set up as General Manager.
It does lend credibility, allows you to write off operating expenses (though you do have to be careful, you can’t register as an LLC and treat your hobby as a business just to be able to write-off the costs of playing around, you have to make sure you’re legitimately in business).
It also provides me some protection–as you say. The only thing is that it can be expensive to do all of this. It really does help that my husband is an attorney and took care of all the paperwork for me :) I knew he’d come in handy.
Oops I meant that you’re NOT drawing a distinction between a corporation and a LLC.
Just wanted to add a bit of clarity — there’s a difference between being the legal entity of incorporated or LLC, and the tax status of your business. You can be an LLC or Inc. for legal purposes (asset protection, credibility) and still be a pass-through tax entity (sole proprietor or partnership, if there’s more than 1 owner).
I generally recommend that if you are worried about liability you should get business insurance before you worry about the expense/admin costs of incorporation or LLC. Besides, if you don’t do everything right (protect the corporate formalities) then you lose the liability protection.
Great for bloggers to start thinking like a “grown up” business!
~ Elizabeth
Elizabeth Potts Weinstein, attorney
Michelle, check back tomorrow! Part 2 of the series draws some distinctions between the different forms of corporate entities (an LLC is a hybrid).
Elizabeth,
You’re absolutely correct. It’s difficult to hit all of the nuances in a short series – so I always recommend checking with a tax professional or attorney before making the *big* decision to move ahead.
I do address some of the differences between the entities in my follow-up post on tomorrow.
Thanks I will–
Health Insurance?
Does this apply to LLC as well?
This alone makes it worthwhile
I would also add if one wants to get financing from a bank, VC, angel invester or better a government program they are usually looking for corporations with clear business plans (at least here in Canada).
I recently asked my accountant this question. My small business grew, and it’s quite the online enterprise now. But the answer was clear:
There is no distinct advantage beyond being cool with that Inc. at the end of the name.
Also, the cost of accounting would rise sharply (at least, in Canada) so the advantages on savings would get poured back into maintaining the books. Paperwork goes up to once each three months for reporting versus once a year.
Add legal fees, notary fees and more, and it would cost me to be an Inc.
Short story – not smart, even for a six figure business. Long story? Not yet. The time will come, he mentioned, when Inc. does make sense.
James –
To be fair, there are some considerable differences between the US and Canada with respect to corporate entities…
1, Canada is not (yet) as sue happy as the US. We’ve noticed a real shift for our European clients as lawsuits (sadly) become a global phenomenon. Asset protection becomes more of a concern.
2, Health insurance is huge. In the US, individual rates are determined by demographics, health history and physicals. Corporate rates are generally determined by demographics alone – not history or physicals. This can make a big difference to an employer.
3, Bookkeeping as a solo is, due to the SE tax and estimated payments, not necessarily more complicated than for the same-sized corporation (the exception being an s corp).
There are definitely differences from country to country – and even state to state!
@ Kelly – That’s why I said, “At least in Canada.” Should’ve made it clearer, though. :)
Kelly,
Great article. I’m looking forward to part 2.
We recently incorporated (S-Corp election) and have gotten quotes on health insurance. They were actually cheaper for an individual rate. Of course that’s before taking our history!
My question is, if the corporation pays for health insurance, can it write it off?
This post came at a good time. I’ve been considering setting up an LLC for a publishing company idea I’ve been playing around with for some time. This pushed me even more in the direction of taking my idea one step further.
Rick
good writing and advice.
Something to really consider when planning for the future since I have bigger plans for my blogs.
You may also consider incorporating offshore for tax minimization and privacy. Where? That’s the question you should ask a professional.
We provide free online consultations on offshore services at http://www.isla-offshore.com/ – feel free to contact us.
Thank you, Darren, for the great article!
In light of the crackdown on offshore accounts by the US government, I feel compelled to point out that there are few instances where you can legally reduce your taxes by incorporating offshore. This is also true of many other countries such as the UK, Germany and Australia.
The same is true inside the US when it comes to incorporation – despite what folks claim, it’s rare that you can significantly reduce your tax burden legally by, say, incorporating in Nevada or Delaware.
One example that does work is by separating your intellectual property out of your company and licensing it to yourself – but that tends to be above the scope of what makes sense for freelancers (not to mention the costs). I can’t stress enough how important it is to consult with a tax pro before making a decision to minimize your taxes by incorporating somewhere else – depending upon the industry, your location, etc., it may not work for you.
Thank you Kelly, you’re right. To make a decision to incorporate offshore you should consider lots, every case is different. Generally it’s not only about taxes and/or liability. I think I should make some more research as to applying offshore tools to the case of bloggers and freelancers and prepare a separate review. Yes, it’s a good idea, thank you again!
It really helps legitimize your business and show potential customers or clients that your business is serious.
I was interested in the comment that setting up a corporation or LLC somehow will protect all your assets. The bottom line is that is not true. You will always be responsible for your own individual actions, whether or not you do them as a employee of a corporation/LLC or otherwise. The asset protection afforded by a corporation/LLC is really a protection of your investment. If I invest $10,000 in XYZ, Inc. stock and XYZ, Inc. gets sued and found liable for $100,000 in damages, I as a shareholder in XYZ, Inc. cannot loose more than the $10,000 I invested.
Jeff,
I don’t think anyone meant to imply that you’re afforded complete protection with an LLC… You’re absolutely right in that you’re still responsible for your actions – that’s why I said in my post that you can’t just write, promote or do what you want and be protected. This is especially true with writers and bloggers because largely, you ARE the business.
There’s this idea in law called “piercing the corporate veil” which is when lawyers try to hold members or shareholders of companies personally liable for damages. In those circumstances, the argument is generally that the individuals inside the company were just using the company as a shield for their individual actions. However, there are still some protections if you operate your business properly.
There is a discussion to be had about the effects of self-employment taxes on sole proprietors vs. s-corporations vs. LLC/partnerships. There is a solid potential to save some on this substantial tax via an s-corporation. Yes, you must pay a reasonable salary, but there is room for some savings.
The entity may also allow some tax savings from family income shifting; gifting some stock to family members in lower tax brackets.
Good accounting for a small corporation should be no more or less than good accounting for a sole proprietorship.
In regards health insurance, the best bet is a c-corporation, which would allow a complete deduction. S-corporation health insurance for its owners must be separated, but should be fully deductible as the so-called “self-employed health insurance deduction”.
Finally, state taxes on corporations vary tremendously; some almost kill any federal tax benefit with additional state taxes at the entity level.
Tom –
You make a great point re state taxes!
In NJ, for example, there is a min annual tax on LLCs that makes savings for federal purposes largely moot for smaller entities (I think it was $500 min for 2007). Also many states that don’t have state taxes – like DE – have annual fees that can add up.
Always best to check first!
Everyone should not be so fast to “assume” that your Corporate Insurance rates will be cheaper than individual rates. Typically, the smaller your group, the higher your rates. The insurance companies do this to protect themselves. Otherwise people in poor health would go set up a 2-person group, just for the low insurance. I have many clients who have gone through this and the individual rates are almost always cheaper than the corporate rates on these small 2-4 person groups. I have no idea what the insurance companies consider the “magic” number of employees before the rates get better, but it isn’t two. Of course, the rates also vary from carrier to carrier and are much dependent on levels of coverage. I would check around before assuming anything.
I have a ton of comments on the tax stuff, but I think they will be mostly already covered in the next post – so I will wait until I have read that one.
What next post?
If I want to incorporate, can I still incorporate before April 15th in order to do 2008’s taxes as a corporation?
Hi,
Offshore corporations have several advantages over incorporating in the country you do business. These include asset protection from lawsuits, increased privacy, confidentiality, dramatically reduced taxes, a global presence, and more flexible business laws than in your home country. Thanks for sharing.
Thanks
Sofia.