Many people are operating full or part-time small business and seeking to incorporate for tax reasons, professionalism, and liability protection. However, most of them are getting it wrong in choosing an entity.
The popular thing to do is form an LLC (limited liability company) because it is simple and requires less formalities than a corporation. While both a corporation and LLC generally provide the same liability protection, the LLC may have negative tax consequences.
A single member LLC (that is, one formed with a single owner) is treated for federal income tax purposes as a “disregarded” entity. That is, for tax purposes, the IRS wipes away the LLC and taxes the single member as though the LLC does not exist. If you are engaging in a business that involves actively-earned income, you will report that income on a schedule C of your personal return. This means that you pay self-employment tax of 15.3% on your earnings. It also means you are more likely to be audited since the IRS statistically audits more small business schedule C returns than they do corporate returns.
For many small businesses, a corporation may provide better tax advantages by sheltering some of the self-employment tax and reducing the risk of audit.
Finally, don’t fall for the Nevada corporation trap. These companies advertise on radio selling the advantages of an NV corporation or LLC, when in fact there is little if any, advantage to a local corporation or LLC if you operate within the borders of your state.
In short, don’t make improper assumptions based on what others do or say. Seek professional legal and tax counsel about your small business before proceeding.