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Since the introduction of the new tax laws, many of our clients and future clients are thinking whether to incorporate or not under new tax law? In short, how to save money? How to maximize deductions? So let’s dive in and let’s make this easy for you to understand by taking a look at various scenarios:
When To Incorporate:
- If you are an employee claiming unreimbursed employee expenses on a Schedule A: In such case, you have to ask yourself three questions before opting for incorporation. How much are you losing in tax deductions? Are you ready to be an individual contractor? And, are you a highly compensated individual? Find out what changed for individual tax payer in 2018. For the first question, it should be noted that there are various costs involved in incorporation. That means, at the end, you should not be exchanging one expense for the other. Secondly, you can save a lot of taxes when you choose to be an independent contractor rather than being an employee as you can deduct a lot of expenses (deducted as business expenses) on Schedule C. But first make a complete check of all the factors, read about what changed for business in 2018 and then take the step. As far as the third question is concerned, do not incorporate unless you are a key employee in your company.
- If you are a pass-through business and a specified service business with a taxable income above the threshold amount: If you are a high-income taxpayer in a specified service business like law, health, athletics, consulting, brokerage services, financial services, etc., you don’t have any benefits of the deduction. There are high chances that you may end up paying double tax – at the corporate level and individual level. Read more about Section 199A- Impact on Small and Pass Through Business. You do require a lot of tax planning in this case, wherein you can maximize your expenses caused by the corporation. Only then will you be able to benefit from deductions. Read about opting out of S election for small business corporation.
- If you are a pass-through business other than a specified service business with a taxable income above the threshold amount: In such cases, it is important to first analyze how you will be saving your taxes. The taxes and fees for incorporating may vary from state to state. That being said, you might not get the benefits you are looking forward to one state and you might get the results in some other state. So, have a look at how things work in your state and accordingly opt for incorporating. Only then you will be able to benefit from it.
May be To Incorporate or Not To Incorporate:
- When you are a sole proprietor and filing Schedule C: In this case, the answer is not as simple as one would think. There is no tax benefit to incorporation if you are only worried about the loss of deductions on your Schedule C. If you are a taxpayer who claims employee-related deductions in Schedule A, then only will the elimination of deductions affect you. On the other hand, if you are a businessman and file Schedule C, this will have no effect on your business-related deductions.
- If you are a pass-through business with a taxable income below the threshold amount: For individuals, the threshold amount is $157,500 and for married taxpayers, it is $315,000. Compare 2018 with 2017 tax brackets. If your taxable income below this threshold amount, there is absolutely no tax benefit to incorporation as you can easily qualify for the pass-through deductions.
When Not To Incorporate:
- If you have rental properties and filing Schedule E: There is no tax benefit to incorporation as Schedule E remains the same. Your rental property mortgage will remain deductible on your Schedule E. In case of properties reported on Schedule A, the limits and caps on mortgage interest and real estate taxes will apply.
- If you have a farming business and filing Schedule F: Similar to rental properties, there is no tax benefit to incorporation if you have a farming business and are worried about the deductions on Schedule F. Your Schedule will remain the same and your farm-related expenses will remain deductible on your Schedule F. In case of properties reported on a Schedule A, the limits and caps on mortgage interest and real estate taxes will apply.
There is no one size fit all scenario as every individual tax situation is unique. Taxes do not work in a simple way rather they are very complex. So, it is important to take advice from n tax expert rather than planning everything by yourself. After all, “The hardest thing to understand in the world is the income tax.” – Albert Einstein. Contact us or learn more about services. You might be interested in reading cryptocurrency and taxes.
