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Small Business Tax Trap 1: Waiting To Incorporate What A

July 25th, 2010 |

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Small Business Tax Trap 1: Waiting To Incorporate What A Difference A Date Can Make

If you’re a sole proprietor perhaps you’ve consideredincorporating your small business or selfemploymentactivity.

And so maybe you’ve been wondering”When is the best time to incorporate?”

>From a legal standpoint any time is the best time.The sooner you incorporate the sooner you make the movefrom the world of unlimited liability to the world oflimited liability.

>From a tax savings standpoint any time is the best time.The sooner you incorporate the sooner you will startputting more money in your own pocket and less inUncle Sam’s.

(For more about the potential tax savings of acorporation see the second article in this series”Tax Trap 2: Double Taxation Isn’t Once Enough?”http://www.YouSaveOnTaxes.com/taxtrap2.html)

But from a **tax reporting** standpoint there is one timeof year that stands out as best: January 1st.

Why is that?

Assuming you have a sole proprietorship (or other entitysuch as a partnership) that is up and running as ofJanuary 1 and assuming you then incorporate thatexisting entity on any date other than January 1you face the possibility of filing not one buttwo business income tax returns for that year.

Here’s an example to clarify this important point . . .

Let’s say you’ve been operating your sole proprietorshipfor a few years and in early 2006 you decide toincorporate. In January you get around to startingthe paperwork but life gets in the way andyou finally get it done in late February. By the timeyour state processes the Articles of Incorporationthe start date of your new corporation is March 1.

For 2006 you must file a Schedule C for the periodof January 1 through February 28 when your businesswas still a Sole Proprietorship. And you must alsofile a corporate income tax return for March 1 throughDecember 31.

Maybe that’s no big deal. Maybe you enjoy filingone business income tax return so much filinga second one doesn’t bother you. And it may bethat the inconvenience of filing two tax returnsin 2006 is far outweighed by the legal and taxadvantages of incorporating.

Keep in mind too that 2006 will be the only yearyou have to do this “double duty”. In 2007 youwill only have to file the corporate income tax return.

But if you are thinking about incorporating thebest time to do it from a tax paperwork standpointis as of January 1. Only then do you have a “clean break”from the old sole proprietorship to the newcorporation.

This timing issue can also be relevant if youdecide to make the switch late in the year. Ifthe effective date of the incorporation is November 15you will have to file a Schedule C for January 1through November 14 and a corporate return forNovember 15 through December 31. In that scenarioyou should ask yourself “Do the benefits ofincorporating outweigh the convenience of waitinguntil January 1?”

So before you decide when to incorporate take a momentto reflect on the tax reporting consequences ofincorporating on January 1 vs. any other date.

Sometimes it may make sense to wait a few weeks(as in the second example) and sometimes it makes senseto “do it now” especially when January 1 is nearby.

NOTE: This is the first in a series of 5 articles:”Small Business Tax Traps and How To Avoid Them”

About the writer:

Wayne M. Davies is author of 3 taxslashing ebooks for small business owners and the selfemployed.For a free copy of Wayne’s 25page report “How To Instantly Double Your Deductions” visithttp://www.YouSaveOnTaxes.com.