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Forming a company has many advantages to simply operating a business as your self or as a sole proprietor. Some of these advantages include personal asset protection, brandability, credibility, deductible expenses, perpetual existence, access to capital and legal liability. Depending on your actual business you may even be required to form a company. However another important element that is equally important is tax flexibility. In other words, by forming a company you can actually save thousands to hundreds of thousands of dollars in tax payments.
Here how it works
If you are a business owner operating as Sole Proprietorship and make about $60,000 a year, you pay self employment tax and regular income tax. As a business expense, you can deduct half of that self employment tax. This is a simple calculation.
Profit as Sole Proprietorship: $60,000
Total Gross Income: $60,000
Half of self employment tax: -$4,500
Adjusted Gross Income: $55,500
Total self employment tax: $9,000
Income Tax: $8,880
Total Taxes paid: $17,880
However if you convert your business to a company, you don’t have to pay the self employment tax and instead you pay Social Security and Medicaid tax which is almost half the rate of self employment tax. Here is the calculation of possible taxes.
Profit as a company: $60,000
Salary Paid to yourself: $25,000
Profit left after salary paid: $35,000
Total Gross Income: $60,000
Social Security and Medicaid Tax: -$1,912.50
Your Adjusted Gross Income: $58,087.50
Total SS and Med. Tax: $3,825
Income Tax: $9,294
Total Taxes paid: $13,119
TOTAL TAX SAVINGS: $4,761
Of course as a business owner you would like to save taxes.
Corporations and LLCs are both separate legal business entities that enjoy certain protections under the law and important benefits. Incorporating, or forming a Limited Liability Company (LLC), allows you to conduct your business without worrying that you might lose your home, car, or personal savings because of a business liability.
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