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Incorporating: Tax Strategy or Big Mistake

By PBS Tax & Bookkeeping Service

Tax Tip
One of the best tax strategies you can put to work for you is an income tax projection. Having an income tax projection done will let you know what your potential tax liability is well in advance of the end of the year to give you time for tax planning. As a business owner you need to know your tax liability. The reason that you need to know is to enable you to plan your next six months to a year. You may be planning to purchase a new truck, to take some time off, to do a major truck overhaul, to fix up your home or to add to your retirement savings. It's a good idea to have your records looked at by your tax preparer throughout the year so that he can spot potential problems or adjust your estimated taxes. A tax projection based on your operations through August or September will best indicate your tax position come April 15. That gives the tax preparer a full eight or nine months of operations for the current year so that he can project and properly estimate how you will do for the full twelve months. The tax preparer can then prepare a tax projection and leave enough time until the end of the year to do proper tax planning.

Incorporating
There are two major reasons why one should incorporate their business. One is to save on income taxes and the other is to protect assets. When considering incorporation for tax savings purposes, the net profit from the business must first reach a significant level--a level high enough to cover the increased operational costs while also insuring tax savings.

Once this profit level is reached, how can you save money on your income taxes and take enough money out of the business to live? This can be accomplished by becoming an S-Corporation. A frequently asked question is: "Since all the income of the S-Corporation is taxable through the owner-employee, how much of it must be taken as salary?" The salary that you are taking must be reasonable for the amount and quality of services that you provide to the corporation. You can decide this by looking at what other similarly situated persons earn. If you decide not to take a salary and only take distributions from your corporation, the IRS can call the distribution dividends, possibly terminating the S-Corporation election and impose taxes at both the corporate and shareholder level. Remember, the determination of a reasonable salary is complicated. It is important that you have your tax advisor make this computation.

The tax savings that one will realize by incorporating and subsequently becoming an S-Corporation is achieved through proper tax planning. If you choose to become a C-Corporation as opposed to an S-Corporation, there are benefits to the C-Corporation that the S-Corporation does not have. Those benefits are in the area of "employee benefits" such as medical reimbursement plans, medical insurance, disability and group life insurance, pension and profit sharing plan possibilities. However a C-Corporation faces the costly issue of double taxation and therefore is not as tax efficient as an S-Corporation.

Since we have talked so far about saving taxes as one of the major reasons for incorporating, how do you know you are earning enough income to make it pay for you? Or, how much tax will you save by incorporating as an S-Corporation to offset the increased costs, but yet have enough money left over to make it worthwhile? Your tax advisor can do the tax projections necessary to make that determination. The projection must be directed at the level of your profits as well as your ability to maintain that profit. When you have your bookkeeping done on a regular basis, your tax advisor can determine from the operating statement if it seems advisable to incorporate or to continue as an existing corporation.

Many truckers have made the mistake of incorporating their businesses without proper tax and legal guidance. Many "filing services" will have you believe there is nothing to incorporating, just file some papers with the state and off you go. Wrong! When it comes to making decisions about your business, it is always good business to get the advice of both a legal and tax professional. Even if it requires a consultation fee, it is well worth the fee to avoid a potentially costly mistake. An attorney will advise on the legal ramifications of incorporating and an accountant will advise on the tax consequences (and there are always tax consequences). A "filing service" cannot advise you on either.

Operating as a corporation is the most expensive way to run a business. A corporation has many strict requirements and guidelines that must be followed that most truckers are not aware of. For example, a corporate tax return will need to be filed each year in addition to the individual tax return. Strict payroll requirements means payroll withholdings, payroll tax deposits and quarterly payroll tax return filings. In addition, corporations have more complex bookkeeping requirements and most owner-operators will not be able to handle this on their own. Even a bookkeeping service must adhere to the strict requirements of maintaining a corporation's general ledger. And don't forget that annual meetings must be held, corporate minutes maintained and resolutions prepared reflecting all significant corporate activities. Fees for meeting all these requirements can really set you back if not prepared.

In some cases incorporating can be very advantageous, but many truckers find out the hard way that incorporating costs them much more than it will ever save them. Learn all the implications before you incorporate. Seek the advice of your tax preparer and attorney to be sure the advantages are going to be well worth the extra time, effort and cost. Beware of services offering quickie filings in Nevada and Delaware. Unless a trucker actually lives and does business in these states, most are much better off simply incorporating in their home state. This also holds true of LLC (Limited Liability Company) filings.

Everyone's financial situation is different. This article does not give and is not intended to give specific accounting and/or tax advice. Please consult with your own tax or accounting professional.

This article has been presented by PBS Tax & Bookkeeping Service, a company that has been providing income tax and bookkeeping services to the trucking industry for over a quarter century. Contributions to this article were made by Shasta May, Director Business Development for PBS. If you would like further information, please contact us at 800-697-5153. See our website at www.pbstax.com.