Many new small business owners struggle with whether or not to form a corporation or remain as sole proprietors for their businesses. Forming a corporation seems like a lot of work, especially with all of the forms and fees you need to submit, but there are some tax benefits to forming a corporation that small business owners should know about before they make a final decision. Knowing the advantages of forming a corporation for tax purposes can save you money in the long run.

Forming a Corporation Reduces Tax Liability for Sole Proprietors

If you continue to operate your business as a sole proprietor, you will have to pay a self-employment tax on the profits you earn from your business. This self-employment tax is high and it can pt a dent in the money you are able to keep after taxes. If you form a corporation, you only pay the self-employment tax on your own personal income paid to you through the corporation. That means if you make $100,000 with your business and pay yourself a salary of $40,000 per year, you will only have to pay the self-employment tax on $40,000 worth of income. This can lead to substantial tax savings.

Forming a Corporation May Make You Eligible for More Deductions

If you are a sole proprietor, the payments you make for health insurance premiums are not considered deductible for tax purposes. However, if you have formed a corporation, your health insurance premiums may be considered deductible. This can reduce the amount of taxable income and reduce the amount of money you pay for taxes each year.

Forming a Corporation Can Make You Eligible for Special Tax Programs

Some counties or cities offer special programs for small businesses operating within their areas. These programs often include incentives for opening a small business in the area and tax advantages that you normally wouldn't be able to take advantage of without these programs. The reasoning behind these programs is that the tax advantages and other benefits will encourage new businesses to open, resulting in more money being brought into the local economy. If you form a corporation, you may be eligible for more of these programs than if you remained a self-employed sole proprietor.

Forming a Corporation May Reduce Your Chances of an Audit

The Internal Revenue Service generally audits a higher percentage of sole proprietors who have not formed corporations than sole proprietors who have formed corporations. While forming a corporation is not a guarantee that you will never be audited, it gives you some added protection and may prevent you from having to go through the time-consuming and potentially costly auditing process.

The tax benefits of forming a corporation make it an attractive option for small business owners. If you're thinking about starting a corporation, speak with your attorney and accountant. They'll help you come up with a plan that helps you meet your individual needs and protect your financial interests so that you can run a successful business.