Someone once remarked, "Next to being shot at and missed, 
nothing is quite so satisfying as an income tax refund."  

There's no question that saving money on taxes is high on 
everybody's list of financial priorities---especially 
self-employed business owners.  

However, unlike individuals who work as employees, business 
owners actually have the "luxury" of choosing how much in 
taxes they pay each year by picking one form of business 
entity over another---such as a sole proprietorship, 
partnership, corporation, or limited liability company.  

Unfortunately, the majority of business owners choose a 
business entity once---usually when starting out---then keep 
the same entity for the life of the business.  

This isn't necessarily always the smartest thing to do. 

While some companies can get away with sticking with the 
same form of business entity throughout the life of the 
business, countless others are just throwing money away by 
paying more in taxes than they have to.  

For some smaller business owners, this financial nonchalance 
can actually cost an extra several thousand dollars in 
unnecessary---and avoidable---taxes each and every year. 

If you're a business owner concerned about reducing your tax 
liability, here's a way you can dodge the tax bullet by 
utilizing what's known as a Subchapter S corporation:  


FIRST SOME BACKGROUND: 

When starting a new business most entrepreneurs focus on 
simplicity: that is, the less paperwork and regulations to 
contend with the better. What this means is that most new 
businesses start out as "unincorporated" entities such as 
sole proprietorships (73%) and partnerships (6%).  

While management and administrative costs of running the 
business might be easier and less expensive initially, the 
tax burden---especially the self-employment tax---can be 
anything but. 

For many business owners who wait until year-end to do their 
tax planning---or who do no tax planning at all---the 
self-employment tax is an unwelcome surprise---and a very 
large expense.  

Newly self-employed individuals are shocked even more once 
they realize that they're responsible for the 
self-employment tax all on their own. That's because when 
they worked as an employee their employer was responsible 
for paying one half of the self-employment tax.  


SELF-EMPLOYMENT TAX PARTICULARS:

** The self-employment tax is simply a version of the same 
Social Security and Medicare taxes you pay as an employee. 
However, instead of paying 7.65% as you do when you're an 
employee, as a self-employed business owner you have to pay 
double: 15.3%.  

** In 2004, the Social Security portion (12.4%) is levied on 
the first $87,900 of net profits. There is no limit to the 
Medicare portion (2.9%).  

** Self-employed individuals are also entitled to a one 
half-credit of the tax.  

** As an example, a self-employed individual with $100,000 in 
net profits in 2004 would be required to pay approximately 
$12,766 in self-employment tax.  


NOTE: This tax is in ADDITION to federal, state and local 
taxes!  


HERE'S WHAT YOU CAN DO TO SAVE MONEY ON THE SELF-EMPLOYMENT 
TAX:  

Incorporate and elect Subchapter S status. You can elect 
Subchapter S status even if you have a pre-existing C 
corporation.  

Operating your business as an S corporation is one of the 
very few four leaf clovers still left in the tax code. The 
reason for this is simple: The net income from an S 
corporation is NOT currently subject to the self-employment 
tax.  

If structured and implemented properly, an S corporation 
could save you thousands of tax dollars per year. As an 
employee-shareholder of your S corporation, you pay yourself 
wages just like you would any other employee.  

But instead of taking profits out through payroll, you take 
cash distributions called nontaxable dividends.  

Nontaxable dividends are called nontaxable, because they 
aren't double taxed like the dividends paid to shareholders 
in a regular C corporation (although beginning in 2008 most 
dividends will no longer be taxed).  

You're still paying taxes on the net income of your S 
corporation when you file your personal tax return, but the 
tax is federal tax and NOT the self-employment tax. 

For the sake of simplicity, if an S corporation with 
$100,000 of pre-tax and salary profits pays its owner a 
reasonable salary of say $50,000 and non-taxable dividends 
of $25,000, the tax would be $7,650.  

** This is a whopping $5,116 savings in tax compared to the 
$12,766 a sole proprietor would pay on profits of $100,000!  

Even if you factor in additional costs such as workman's 
comp insurance, incorporation costs, professional fees and 
incidentals, the savings is still more than adequate.  


CAVEATS:

** The key to successfully implementing this strategy is that 
your salary must be REASONABLE under the circumstances 
surrounding your business. It's also much better for salary 
justification purposes if your business is not limited to 
the delivery of personal services by you.  

** At personal income levels close to the Social Security wage 
base ($87,900 for 2004), the benefits of using this strategy 
diminish. 


BUT HERE'S SOME MORE GOOD NEWS: 

If you happen to already own a regular C corporation and you 
live in a state that has a high corporate income tax rate 
and a low personal one, you'll come out ahead even more if 
you elect S status. 

Additionally, if you have children aged 14 or older, you can 
save even more taxes by giving them shares in your S 
corporation and having them pay the tax at their lower tax 
rates.  

By giving away shares you also reduce your estate tax 
obligation. 

So you see, there are plenty of good reasons to incorporate 
and elect S status. I've only touched on a few minor points. 
 
In my small business strategy guide --- 
http://www.goldminetactics.com/successmanual.htm --- I devote 
three chapters to MASSIVELY reducing business income taxes.  

Just keep in mind that you should ALWAYS consult with your 
tax advisor and attorney before making any important 
business or financial decision. 

Your financial situation is unique and the information in this 
article may not be appropriate for your particular situation.  

Always look before you leap.

When it comes to your business, you should make it a point 
to assess the validity of your type of business structure on 
a yearly basis.  

Incorporating is definitely not just for startups. There are 
plenty of unincorporated businesses that are missing the 
boat when it comes to saving money. Don't be one of them.