Corporations are separate and distinct business entities from any person associated with the corporation such as shareholders, officers or employees. Many closely held corporations (those with under five shareholders) fall into the habit of treating the corporation like it’s just another version of a sole proprietorship. It’s not.
Even if you’re the only shareholder and officer of the corporation, you have to treat any business you incorporate like an unrelated business. So, for example, just as you wouldn’t walk up to your boss now and ask her to cut a check to pay your mortgage payment, you can’t treat the corporate checking account like it’s your own personal piggy bank. It’s just not proper to pay personal bills out of the corporate checking account.
Formation
It is more complicated to set up a corporation than a sole proprietorship, as you have legal filing requirements with both your state and the federal government. The person that is in charge of getting the corporation off the ground (that’s probably you) is responsible for filing articles of incorporation with the Secretary of State where the corporation is located.
You stake ownership rights to the corporation by purchasing shares of its stock. The number of shares of stock sold determines ownership percentage. If you purchase the only share of stock issued, you are the 100 percent shareholder, totally in control of the corporation and all decision making.
All corporations have to apply for an employer identification number from the Internal Revenue Service using Form SS-4.
Liability
I’ve found that most people incorporate their business because of the limited liability aspect. With very few exceptions, you as the shareholder or officer of the corporation are not personally responsible for any actions taken against the business.
A couple of notable exceptions are the trust fund portion of the payroll taxes and sales tax you collect from customers. If you don't timely remit your payroll taxes or sales tax liability, the fed or state government can come after you personally for collection.In case you’re not familiar with the term trust fund being used this way, the trust fund portion of payroll taxes is the part withheld from the employee’s check – the part that makes up most of the difference between gross and net wages: federal withholding tax, FICA and Medicare.
Taxation
Tax return preparation for a corporation is more expensive. A corporation files a federal Form 1120, which requires keeping both balance sheet and income statement figures. In addition, you also have the responsibility of preparing quarterly payroll tax returns to report wages paid, even if you are the only employee. Most states also require that you file returns and pay tax on corporate net income as well.
Like individuals, a regular C Corporation has a graduated tax rate. The rates start at 15% for net income under $50,000 and go up to a maximum of 35%.
Getting Paid
Well, this part will be familiar – you’ll give yourself a regular paycheck and get a W-2 at the end of the year just like you did at any of your other jobs working for someone else.Just remember, you can’t willy-nilly make loans to yourself in an attempt to get money out of the corporation. If the corporation does loan you money, you have to treat it like a regular debt. Loan paperwork has to be drawn up specifying loan amount, interest rate and time to repay the debt. And the corporation has to record the interest on the note as income.
Disadvantages of Incorporation
Just about all my clients and craft buddies who have incorporated say the same thing – it’s a pain to have to write a formal payroll check every time they want to pay themselves. Once you get the hang of it, it really isn’t that big of a deal to write payroll checks, make payroll tax deposits and do all the necessary reporting. If you don’t want to do it yourself, it’s not all that expensive to hire a payroll service to do it for you.Another big disadvantage is the double taxation of dividends. This is one of the rare instances of double taxation in the United States. If you decide to pay yourself a dividend from your corporation, you have to report it as taxable income on your Form 1040. However, dividends are not a deductible business expense for the corporation so in essence the corporation is paying tax on the dividend too.
Corporations are more work than sole proprietorships to start and manage. If this sounds like too much hoopla for you, check out the basics of runnng your craft business as a sole proprietorship.
