One of the greatest strategies of all for
financial success is a successful business. If your
business is profitable, that equity is the key to big
money. In fact, the miracle of equity is that it
builds itself. All you have to do is reinvest the
profits successfully, and the value of the entity that
made them will increase accordingly.
And even if your business never becomes
profitable, it can help cut your tax bill. Even if it
never grows larger than a tiny "small" business, it can
mean the difference between financial independence and
life as a wage slave.
The 1986 tax reforms rubbed off some of the shine,
but a small business is still one of the best tax
shelters. And, contrary to what you may have thought,
starting your own enterprise doesn't require a radical
departure from your current income.
There are two ways you can profit from business
ownership while, in effect, keeping your present job:
independent contracting and a sideline business.
A business of your own will help you realize a
dream of financial independence. To succeed all you
need is a motivation to succeed, some no-nonsense
planning, a competitive spirit, and the energy to
achieve your goals.
In addition to equity, the most important
component of self-employed wealth is that you are able
to deduct many of your expenses.
A regular corporation allows you to turn many
items you might normally buy out of your own pocket
with after-tax dollars into deductible expenses by
making them tax-free fringe benefits the business
provides for its employee -- you. You don't need to
have any other employees to take advantage of
incorporating.
If you do have employees, the tax treatment of
employee benefits is another advantage of incorporating
your business. Tax rules recognize two general types
of fringe benefits: those that are identified
specifically, and those that fall into broader
categories.
Specific benefit plans that are tax-free to
employees and deductible by the employer are:
* Accident and health insurance plans
* Group-term life insurance up to $50,000
* Prepaid legal services
* Cafeteria or flexible-benefit plans
* Vanpooling
* Scholarships and fellowships
* Dependent care assistance
* Education assistance related to the employee's job
Let's look at health insurance as an example of
the advantage of incorporating. Many people who leave
an employer to go out on their own are shocked by the
health premium they have to pay on their own. A family
plan with comprehensive coverage and dental benefits
could cost you $400 a month or more. By incorporating,
you can have your company provide your insurance and
deduct it as a business expense.
And the benefit does not count as income for your
individual tax purposes. The restrictions on these
plans require that the benefits be available to a
reasonable cross section of employees, as defined by
various mathematical formulas in the tax code and IRS
regulations. Benefits will not be tax-free if they are
available only to officers or highly compensated
employees.
Obviously, this does not present a real problem to
the one-employee corporation. You must draft your
benefit plans so that if you do hire permanent full-
time employees in the future, they will be eligible for
benefits.
For small-corporation employees, one of the
biggest of these benefits is tax-deductible life
insurance. The most common way to get tax-deductible
life insurance is through a group term insurance plan.
An employee receives the first $50,000 of coverage tax-
free and must include as income only a percentage of
the premium attributable to coverage over $50,000.
The taxable amount is determined by consulting an
IRS table. The coverage for each employee must be
provided using a formula that takes account of factors
such as age, years of service, compensation, and
position in the company. The employer must own the
policy.
A drawback to these plans is that coverage usually
ends when an employee retires, and some retired
employees continue to need life insurance. Coverage
for retired employees is very expensive.
When you own a business you may be able to...
* turn "personal" expenses into tax-deductible dollars
* split income among family members to avoid the
effects of progressive tax rates
* have the business pay you in tax-free fringe benefits
instead of a taxable salary
* deduct your vacation costs, under certain conditions
* write off your home office
But be sure to...
* weigh the costs of going it alone
* appear independent
* keep good business records
* follow closely the rules on employing family members
* consult experts before setting up complex benefit
plans
* pay your estimated taxes each quarter
General benefits
Broad groups of benefits that receive tax
advantages include the following:
* No-additional-cost services are tax-free when
provided by the employer (or another business under a
reciprocal agreement with the employer), and the
employer does not incur a substantial cost (including
foregone revenue) in providing them. An example might
be allowing your waiters to have free lunches at your
restaurant. The service must be provided by the same
line of business in which the employee works.
* Qualified employee discounts are tax-free when the
discounts do not exceed the employer's gross profit
margin on the product. Discounts on services cannot
exceed 20% of the price charged to other customers.
Employee discounts must be from the line of business in
which the employee works.
* Working condition fringes are property or services
that would be deductible trade or business expenses if
the employee paid for them himself. Parking on or near
the business premises is considered a working condition
fringe benefit under the new law. The employer can
deduct it, and the employee needn't count it as taxable
income.
* De minimis fringes are tax-free if their value is so
small that accounting for the benefits is unreasonable
or impractical. Typing a personal letter, cocktail
parties, picnics, and holiday gifts are de minimis
fringes. Personal use of a copying machine is tax-free
if the employer can show that 85% of the machine's use
is for business.
