TO INCORPORATE OR NOT TO INCORPORATE

by Andrew D. Schwartz, CPA

It's an age-old question.  One Hamlet probably asked to his CPA on more than one occasion, assuming he did some moonlighting or consulting on the side.  "To incorporate or not to incorporate, that is the question."

In certain instances, creating a business entity is a must.  If you open a business with another person or have other professionals working for you, you'll want set up your business as either a corporation or a Limited Liability Company (LLC) to protect yourself from your co-workers mistakes.  And if you're worried about potential product liability, or want to protect against certain other risks, then incorporating might be the way to go. 

But what if you earn a good salary each year, and then earn some extra money on the side by moonlighting or consulting?  Does it make sense to incorporate?

The Costs

Like every business decision, you first need to evaluate the costs and benefits of incorporating.  Let's start with the costs.

• It costs money to incorporate.  In Massachusetts, expect to pay about $1,000 in legal and filing fees to incorporate.  You also need to budget another $1,000 or so in fees when you're ready to dissolve your corporation.  The fees in your state probably won't be much different.

• Many states require corporations to pay a minimum tax each year for the privilege of doing business in their state.  In Massachusetts the minimum tax for corporations is $581 per year, in California it's $800, and in NYC expect to pay $400 per year.  That doesn't include the cost of having a CPA firm prepare your corporate tax returns, which could easily run $500 per year or more.

• You also need to put yourself on payroll.  If you don't want to deal with all the headaches associated with payroll, you have the option of either having your CPA help you out or using a payroll service.  Either way, expect to pay at least $600 per year.  And don't forget about state unemployment taxes and workers compensation insurance on your salary.  The amount you'll owe varies by state, but if your state is similar to Massachusetts, you'll pay a minimum of $300 per year.

• Don't forget about the extra social security taxes.  This quasi-hidden tax can get quite expensive to people who incorporate.  That's because your corporation, just like your other employers, is required to withhold social security taxes at a rate of 6.2% on the first $90,000 (in 2005) of salary earned from them.  Each corporation then matches the social security taxes withheld from your pay.  So while you'll get back any social security taxes withheld during the year on the salary drawn from your corporation (assuming your salary from another employer exceeds the social security max of $90,000), you don't get back the company match.  Draw a salary of $50,000 from your corporation, and the government keeps the $3,100 company match.  As a sole proprietor, you wouldn't pay this tax. 

So let's recap the costs of incorporating, assuming it's your first year in business, you pay yourself a salary of $50,000, and you earn more than $90,000 in salary from another employer:

The Benefits 

Okay, for $6,000, you'd expect some pretty big benefits, right?  Besides possible protection from some risks (which you would need to discuss with your attorney), what are the benefits of incorporating to a professional who earns a good salary each year and does some moonlighting or consulting on the side?

I don't have a good answer for you.  Pretty much everything that is deductible to a corporation is also deductible to a sole proprietor.  Some expenses, such as the home office deduction and vehicle expenses, are actually easier for an unincorporated business to claim.

Do you any children under the age of 18?  If so, you can reap a huge tax break by employing your child - provided you don't incorporate.  While you as the parent and business owner get to deduct the wages paid to your child, the child owes no federal income taxes on up to $5,000 earned (in 2005), and no social security, Medicare or unemployment taxes on any money earned from you.  Once you incorporate, this tax break is no longer available.

And if you're looking to shelter some of your income by setting up a tax-advantaged retirement plan, you can set up an equivalent retirement savings plan for your sole proprietorship as you could for a corporation.  These days, self-employed individuals are setting up Solo 401(k) plans, SIMPLE IRAs, or SEP IRAs.

Look at the Numbers

Before you go through the expense and effort of incorporating your moonlighting or consulting business, take one more look at the numbers.  You might find that the costs of incorporating far exceed the benefits.

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DO YOU HAVE A HEALTH CARE PROXY?

by Attorney Neil Cohen

The Health Care Proxy is a simple legal document that allows you to name someone you know and trust to serve as your Agent and make health care decisions for you if, for any reason and at any time, you become unable to make or communicate those decisions.  It's an important document, however, because it concerns not only the choices you make about your health care, but also the relationships you have with your physician, family, and others who may be involved with your care.

Your Agent will make decisions about your health care only when you are, for some reason, unable to do so yourself.  This means that your Agent can act for you if you are temporarily unconscious, in a coma, or have some other condition in which you cannot make or communicate health care decisions.  Your Agent cannot act for you until your doctor determines, in writing, that you lack the ability to make health care decisions.  Your doctor will tell you of this if there is any sign that you would understand it.

Acting with your authority, your Agent can make any health care decision that you could, if you were able.  If you give your Agent full authority to act for you, he or she can consent to or refuse any medical treatment, including treatment that could keep you alive.

Your Agent will make decisions for you only after talking with your doctor or health care provider, and after fully considering all the options regarding diagnosis, prognosis, and treatment of your illness or condition.  Your Agent has the legal right to get any information, including confidential medical information, necessary to make informed decisions for you.

Your Agent will make health care decisions for you according to your wishes or according to his/her assessment of your wishes, including your religious or moral beliefs.  You may wish to talk first with your doctor, religious advisor, or other people before giving instructions to your Agent.  It is very important that you talk with your Agent so that he or she knows what is important to you.  If your Agent doesn't know what your wishes would be in a particular situation, your Agent will decide based on what he or she thinks would be in your best interests.  After your doctor has determined that you lack the ability to make health care decisions, if you still object to any decisions made by your Agent, your own decisions will be honored unless a Court determines that you lack capacity to make health care decisions.

Your Agent’s decisions will have the same authority as your's would, if you were able, and will be honored over those of any other person, except for any limitation you yourself made, or except for a Court Order specifically overriding the Proxy.

Health Care Proxies differ from state to state and are created under state law.  Your state of residence will determine the form you should use, as well as whether you need to sign a second document, called a Living Will.  Some states incorporate the living will provisions right into their Health Care Proxies, but whatever the case, the living will lets you give specific instructions about any aspect of your health care.  Some of the choices you can make by the living will include expressing your wishes regarding the provision, withholding or withdrawal of treatment to keep you alive, including the provision of artificial nutrition and hydration, as well as the provision of pain relief.

Finally, some states have language in their Health Care Proxy that allows you to indicate your willingness to donate organs.  As always the case in these matters, it is a good idea to inform your family members of your desire to be an organ donor and to keep a donor card in your wallet.  Time is usually of the essence.

Neil Cohen is an attorney with the Boston area law firm of Woodman & Eaton, PC.  Neil specializes in the area of estate and gift tax planning, and can be reached at (978) 369-0960.  For more information, please visit the firm website at www.woodmaneaton.com. 

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TAX AND FINANCIAL PLANNING CALENDAR FOR JULY, 2005

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2004 & 2005 TAX FACTS

• For 2004 the standard deduction for a single individual is $4,850 and for a married couple is $9,700. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses. Our March, 1998 newsletter addressed the issue of itemizing your deductions.
• For 2004, the personal exemption is $3,100. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  
• The maximum earnings subject to social security taxes will be $90,000 for 2005 up from $87,900 in 2004.
  
• The standard mileage rate is $.405 per mile for 2005, up from $.375 per mile for 2004. Deducting automobile expenses was addressed in our March, 1996 newsletter .
  
• The maximum annual contribution into a 401(k) plan or a 403(b) plan is $14,000 for 2005.  And if you'll be 50 or older by December 31, 2005, you can contribute an extra $4,000 into your 401(k) or 403(b) account this year.
• The maximum annual contribution to your IRA is $4,000 for 2005.  And once you turn 50, you can contribute an extra $500 into your IRA this year.  You have until April 15, 2006 to make your 2005 IRA contributions. 

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