In the next two to three years, more than 13% of adult Americans (about 29 million workers) are considering the shift to independence.
But your first big decision (other than when to make the jump) is choosing the right business structure.
C corporation status is an increasingly popular option for independents. When most small businesses incorporate, they’re automatically C corporations. The structure is ideal for independents in certain circumstances, as well – typically those earning over $100,000 each year who want to take advantage of certain sophisticated deductions and tax benefits.
Let’s cover the basics first.
A C Corporation is the same status that Fortune 500 businesses hold – they are corporate entities separate from their owners. Owners become shareholders in this new organization. In the case of an individually owned C-Corporation, you are not just the owner of your company, but the majority shareholder.
Because the corporation is a separate legal entity, it is an individual taxpayer in the eyes of the IRS. While this structure is one of the most complex business arrangements available, it is also the most sophisticated – and an attractive option for the savvy independent professional as well.
Separating personal and corporate liability is one of the most valid reasons to consider a separate business status. With C corporation status, your liability is limited to the percentage of the company you own, and it separates your personal and professional assets if your company is ever sued.
C corporation status makes it easy to deduct benefits like group term life insurance, health coverage, and disability insurance as taxes from business expenses – and are exempt from paying taxes on the fringe benefits they receive.
Specifically, C corporations are eligible for Health Reimbursement Arrangements (HRAs), a tax-advantaged benefit that allows both employees and employers to save on the cost of healthcare. HRAs are a special carve-out not afforded to owners of S corporations or Members of LLCs.
In contrast, S corporation shareholders must report the benefit(s) as income and then deduct the premiums from gross income on their personal returns—leaving the net benefit as zero. Self-employed individuals also deduct their premiums from gross income on their personal returns; although they cannot reduce their business income by the premiums allocable to their personal coverage and wind up effectively paying self-employment tax on the premiums.
From both a personal taxes, as well as corporation taxes standpoint, C corporations are 10 times less likely to be audited by the IRS compared to S corporations or LLCs. Of course, you should always make sure that you’re doing things to the letter of the law and keeping appropriate records, so that if you are audited, it’s easy to prove that you are operating compliantly.
All other statuses of self-employed individuals (including sole proprietors, partners and LLC owners) pay self-employment taxes to cover their Social Security and Medicare taxes obligation on all of their net earnings from self-employment. In contrast, shareholder-employees of S and C corporations pay FICA (Social Security and Medicare) taxes only on wages they receive. Additionally, it is less cumbersome to write-off expenses as a C corporation.
Should you decide to add employees, or even sub-contractors, it’s easy to do so with C corporation status.
There may be some drawbacks, however. Since C corporations are viewed by the IRS as a separate entity, they are subject to double taxation: profits are taxed once on the corporate level, and a second time when they are distributed as dividends to the shareholders. However, if you do not distribute dividends (i.e., when you operate as a sole employee), you will be exempt from this requirement. In fact, not distributing dividends will also keep the risk of being audited very low – the IRS tends to look out for single owner S corporations that pay dividends.
Structuring your business the right way can benefit you for years to come, both literally and figuratively, but to truly know what’s best for you, you should discuss incorporation with your legal and/or financial advisors. Typically, one might also consider a C-corporation to be a more ‘heavy handed’ business entity due to the need for set up and advanced reporting requirements.
However, individuals using MBO Partners’ Corporate Services program enjoy the help of MBO to set up their legal entity, manage their reporting requirements, and issue an end-of-year W-2.
Should you be interested in setting up your own C Corporation, give us a call. We’re happy to walk you through the process.
This content from MBO Partners does not constitute legal or financial advice.
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News and notes for independent professionals and their clients. This is our November 21, 2016 edition.