Incorporating and Income Splitting

Understanding how your business form benefits you now and when you are growing is important. Incorporating and forming an LLC have different advantages for businesses in different stages. Know how your business structure will serve you as you now and years after you incorporate. We will cover some advantages and how the LLC can change its status to support phases of your business after incorporating.

We'll examine income taxation and compare how the Corporation and the LLC offer different advantages. For starters, General For Profit Corporations are taxed as a separate entity. Pass through tax entities, such as the Limited Liability Company, do not pay taxes themselves, the owners of the entity have the liability on their personal income tax return. For example, if a Corporation has $50,000 of profit in the business bank account, that sum is taxed at corporate rates. If an LLC has the same amount of profit in the company, the owners are responsible for the tax liability on their personal returns, whether they distribute the money to themselves, or not.

Disadvantages of Corporate Taxation
If the business has little or no need to accumulate money, then corporate tax treatment may not be the best scenario. A Corporation will pay Taxes on any profits that remain in the business. So the situation here presents two levels of taxation:

Personal Income Tax: Shareholders and employees will pay income taxes on all salary and distributions on their personal income tax returns.
Corporate Income Tax: As a separate entity, the Corporation will pay taxes on any profit remaining in the business.

Advantages of Corporate Taxation
Now we can get into income splitting and how the corporate taxation can be a huge asset to grow your business. When you need to accumulate money in the business for future expenses, such as inventory or office equipment, a corporate tax scenario will allow you to do this with some savings on the overall bite the IRS will take. Lets take an example where there is $100,000 remaining profit in the business. If the entity was not incorporated or subject to pass through taxation, that amount would be the responsibility of the business owners on their personal income tax returns and taxed at a rate of their tax bracket. If funds were to be left in the business for future expenses, the owners could distribute half of the profit to themselves and leave the other $50,000 in the company which would be taxed at %15, the corporate tax rate. This saves the owners money at the end of the year. Remember that if this were an LLC the entire $100,000 would be taxed on the owner's personal return, whether the money was distributed or not.

LLC Taxation Advantages
Previously we discussed in this guide that an LLC can choose its tax status with the IRS. You can incorporate as a Limited Liability Company and have the advantageous pass through taxation when you are taking all of the profits out of the business and when that isn't an advantage any longer, you can elect corporate tax status. This will put the company into a position where income splitting is possible for a different phase of your business.

Next Section: Incorporate for Liability Protection