I was asked this question many times. What is the best form to do business? The answer is that there are advantages and disadvantages of both:
1. Sole proprietorship is taxed at the personal level. This means that all your income is added together with your net income (profit) from sole proprietorship and taxed for the corresponding level of your income.
The personal tax rate starts at 25%. The good thing about this form of business is that the loss from your business is combined with your income from other sources (e.g. salary, dividend etc.) and you are allowed to deduct your basic personal amount overall ($9,405) and the loss will reduce your tax payable or even help you to receive a tax refund.
The reverse of the coin is that if you have a profit, this profit is added up with your other sources of income and your tax rate could increase up to 46%.
Situation A – sole proprietor
Net income $40,000
Amount remained for business owner: $40,000 – $7,679= $32,320
2. Corporation is taxed with 15.5% for the first $500,000 income. This tax rate is much lower than 25% or more as in the case of sole proprietorship.
At a first glance now this appears to be the best option. But things are not always as they seem. This tax rate (15.5%) applies only if you leave your money in the company. If you take them out then you are taxed at the personal level (25% and up) for the amount withdrawn.
So in this scenario you will have a double taxation: for corporation 15.5% and personal tax (25% and up).
I present you bellow two scenarios from the corporation approach:
Situation B- Corporation
Net income $40,000
Tax @15.5% $6,200
Amount remained for business owner: $40,000 – $6,200 = $33,800
Amount taxable for owner at personal level: $33,800
Net amount remained for business owner: $33,800 – $6,123= $27,676
Total taxes paid: $6,200 + $6,123= $12,323
Situation C – Corporation
Net income 0
Tax @15.5% 0
Amount remained for business owner: $40,000
Amount taxable for owner at personal level: $40,000
Net amount remained for business owner: $40,000 – $7,679= $32,320
Total taxes paid: 0 + $7,679= $7,679
Let’s see all the scenarios in a snap shot:
|Situation A||Situation B||Situation C|
|Net amount remained||$32,320||$27,676||$32,320|
1. As long as the profit of your business is under $60,000 – $65,000 per year I advise you to do your activity as a sole proprietor because generally this money is needed in a household nowadays so you have to withdraw this amount for your own needs.
2. If you have more than $100,000 as a profit and you want to develop your business even more I advise you to operate your activity as a corporation.
3. To reduce the taxes from the corporation pay yourself a salary and in this way you will minimize your overall taxes.
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To be continued