I've heard that I can save on taxes and write off personal expenses by incorporating myself. How should I go about doing this?

This sounds like a question I'd get on a Monday morning from a client who attended a weekend cocktail party. Personal expenses are generally not deductible against business income.

A corporation is a legal entity designed to exist separately from its owners, the shareholders. The corporation, under authorities granted by the state where it's formed, can enter into contracts, pay taxes, sue and be sued. The goal in forming a corporation is to keep the personal activities from commingling with business transactions.

Many businesses incorporate so they can raise capital to expand the business or easily transfer ownership units. For single-owner businesses, the reasons generally involve protecting personal assets and saving taxes, but these advantages come with a price.

Record keeping requirements are more complicated for a corporation. You must maintain a separate bank account, file annual corporate income tax returns, and pay taxes on corporate profits. Even though you're the sole owner of the corporation, you receive salary just like an employee, subject to the same payroll withholding taxes and periodic tax filing requirements.

A regular corporation, known as a C Corporation, usually has the worst tax bite, with top rates at 39%. You pay taxes on the company profits, and then when you take the money out for yourself, you may pay tax on it again, generally as a dividend. If you're counting, that's paying taxes twice. And if you're a professional who incorporated your practice, you're considered a professional service corporation and your first dollar of profit could be taxed at 35%. On the plus side, a C corporation allows for deductions for medical expenses for shareholders under a medical reimbursement plan that isn't available under other types of entities.

You may be able to minimize taxes through electing a status as an S Corporation. Talk to your CPA to see if this option is right for you, and to file documents in a timely fashion to protect the tax advantages.

The S election allows you to report the corporation's profit on your personal tax return. Depending on your personal tax bracket and the company's profits (or losses), good planning could make a difference in your total tax bill. As a shareholder in an S Corporation, you draw a reasonable salary for which you pay Social Security and Medicare taxes. You're entitled to also take a stockholder distribution, which is not subject to the payroll taxes. If done correctly, you can save up to 15.3% (combined rate for Social Security and Medicare taxes) on the amount of the distribution. Be aware that there are limitations on the amount of distribution allowed before triggering other tax implications. This is why you need the help of a tax professional.

A primary reason to incorporate is to remove the risk of loss due to financial obligations or lawsuit from the personal assets of the shareholders. To accomplish that goal, though, you must walk, talk, look, and smell like a corporation. That means you must file all corporate paperwork in a timely fashion, conduct formal meetings of your stockholders and board of directors, and keep minutes of actions taken. Follow these guidelines, and then if a problem arises, you've taken the steps to prove a true corporate existence.

It's not difficult to form a corporation yourself these days. Go online to your state's website to look for the name you want, check to see if it's available, complete the application, pay the fee, and you'll have a corporation within minutes. But what you do next determines the benefits to you. Talk to your CPA and get all the information you need before you set up the corporation. Planning the tax benefits is unique to each individual, so don't make decisions based on what you learn at a cocktail party.

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