It’s often said that one picture is worth a thousand words. Let’s look, then, at three pictures. Following are tax returns for three businesses at three different income levels, both as corporations and as sole proprietorships. To simplify matters, the individuals are assumed to be single and will take what amounts to the standard deduction. Otherwise, at their income levels, they would lose most or all of their medical deduction.
First, there is Ben Reich, a real estate broker whose earnings are $48,000 a year, with dividend income of $6,000 and medical expenses of $2,000.* Ben prefers to retain as much corporate income as possible, so his corporation pays him a salary of $20,000 a year. His corporate return and his employee tax return, followed by his tax return as a sole proprietor, are shown on pages 215–225.
By accepting the low salary, Ben saves more than 29 percent in taxes: $8,968 as a sole proprietor versus a total of $6,349; $3,713 in corporate taxes and $2,619 (including real cost of Social Security tax) in employee income taxes.
Geoffrey Fourmyle, a technical writer, has chosen a higher salary of $30,000, although his gross income is also $48,000 and his dividends are also $6,000. His medical expenses are $4,000.* By taking the higher salary, however, he cuts his tax saving to 44 percent: $8,337 as a sole proprietor versus a total of $4,696; $2,090 in corporate taxes and $2,606 in employee income taxes. He is sheltering less of his income at the preferential corporate rate; thus, his tax savings are smaller. See pages 226–236 for his tax returns.
Last, there is Maria Beaumont, a successful designer who earned $100,000 last year and had dividend income of $10,000 and medical expenses of $6,000.* By taking a salary of $40,000, she cuts her total tax bill from a maximum tax of $22,662 as a sole proprietor to $14,108, for a savings of $8,554 in just one year. If Maria took a higher salary, her corporate contribution would continue to rise; at $50,000, her corporation could contribute $12,500. However, she would be sheltering less income at low corporate rates. In this return, take special notice of the $10,000 dividend income. Maria’s corporation was able to shelter $7,000 of it (see line 29[b] on page 237), and was taxed on $3,000, for a tax liability of only $450. If Maria owned the stock herself, she would be taxed on the full $10,000, for a tax liability of approximately $1,500, nearly four times greater than the corporate tax. For her tax returns, see pages 237–247.
Let’s summarize the tax savings of incorporation shown on the sample returns this way:
†Includes real cost to corporation of Social Security tax.
In fact, the tax savings on dividend income are so enormous that they deserve their own tables:
As Corporation
Just for fun, why don’t you pull out last year’s tax return and pencil your numbers in on one of the sample returns? If your figures show savings of several thousand dollars a year, it might be a good idea for you to incorporate.
* Excluding insurance.
* Excluding insurance.
