Are you Interested in Generating Some Extra Cash?


ARE 80% OF ENTREPRENEURS WRONG?

About 80% of America's small businesses are unincorporated, according to government statistics. Many of these businesses could reduce their income tax bills by incorporating, because the corporation is still America's best small-business tax shelter.

Let's look at a small retail business that is jointly owned by a husband and wife. The business has gross sales of over $415,000 and a net income of about $48,800. The owners also earn about $4,000 in interest and $1,200 in dividends.

Out of this, they have to pay self-employment tax of about $6,900. They also pay medical expenses of almost $10,000. Because they can deduct only medical expenses that exceed 7.5% of their adjusted gross income, $6,300 of their medical outlay is included in their itemized deductions. Their federal income taxes are about $3,800.

Now suppose they incorporate the business. The first thing the corporation lets them do is establish a medical-expense reimbursement plan under which the corporation pays their medical expenses. The payments are tax-free to the owners and deductible by the corporation.

Other expenditures, such as automobile purchases, could also be paid for by the corporation. The value of the vehicles would have to be included in the owners' gross income, but the expenses would be deductible by the corporation -- and it is cheaper to include them in gross income than to pay for them with after-tax income.

The owners draw salaries from the corporation, but they will not need to draw the $48,800 they are netting as proprietors, because the medical and other expenses are paid by the corporation. By taking salaries totaling about $35,000, they eliminate $2,110 in Social Security self-employment taxes. The standard deduction and personal exemptions cut their taxable income to $22,850. Their federal income taxes for the year are $3,428. Total tax savings from incorporating so far are about $2,500.

Eventually, they can have the corporation set up a pension fund and other benefit programs for them. They can also get more tax-advantaged cash out of the corporation by buying business assets themselves and leasing them to the corporation. The corporation's taxable income up to $50,000 is taxed at its 15% rate, but most small corporations can keep the taxable income around zero.