Small Business Tax Questions: What are the tax advantages of a corporation?
Are you currently running your small business as a sole proprietor and wondering if it makes sense to incorporate? There are many potential tax advantages to forming a corporation. Here are some to whet your tax saving appetite.
1. Deduct all your medical expenses. You can set up a Medical Reimbursement Plan (MRP) and deduct 100% of your out-of-pocket medical expenses. It is very difficult to deduct medical expenses on your personal tax return because you must itemize deductions on Schedule A, and you can only deduct medical expenses to the extent they exceed 7.5% of your adjusted gross income.
A sole proprietorship can have a medical reimbursement plan, but this only works if the owner is married and hires their spouse as an employee of the business. Forming a C Corporation solves this problem, because the owner can be an employee of their own corporation and be covered by the medical reimbursement plan. An S Corporation can also have an MRP, but the tax savings are less than a C Corporation.
2. Deduct all your health insurance premiums. A sole proprietorship can potentially deduct health insurance, but only to the extent of business profits. If the sole proprietor has a loss, they do not receive any health insurance deduction. If the sole proprietorship has a profit less than the health insurance premium, the deduction is limited to the amount of the profit and the rest is forfeited. AC Corporation allows premiums to be deducted regardless of the bottom line. An S Corporation can also deduct health insurance premiums on behalf of an employee-shareholder, but the tax benefits are less.
3. Reduce your self-employment tax. The sole proprietor is plagued by the dreaded self-employment tax. An S Corporation provides the opportunity to legally reduce this tax by having a portion of the profit reported on Schedule K-1, where it is subject to personal income tax but not self-employment tax. Of course, the S Corp owner must still receive reasonable compensation as an employee of the corporation, and these W-2 wages are subject to payroll taxes, which are equivalent to the self-employment tax. But if the fair market value of the owner’s employee wages is less than the corporation’s profit, this is an appropriate strategy for minimizing self-employment taxes.
4. Tax-free fringe benefits. There is a long list of employee benefits that are available to corporate employees. These benefits include the following: educational assistance, employee-provided vehicle, fringe benefits such as holiday gifts and other occasional employee benefits, dependent care assistance, on-site sports facilities, retirement planning services, insurance of life and discounts for employees.