Tax Trap #2 -- Double Taxation: Isnt Once Enough?

Have you been thinking about incorporating your small business or self-employment activity? The advantages are many!

For starters, you'll be protecting yourself and your family from the possible of a business ending lawsuit. Forming a corporation is Step One on the path known as "Asset Protection" -- you are moving from the world of unlimited liability to the world of limited liability.

(NOTE: For further insight into the legal advantages of incorporating, check out the article: "It Can Happen To You: Why Any Sole Proprietorship Is A Risky Business" at

From a tax standpoint, there are both advantages and disadvantages to incorporating. Yes, forming a corporation can either reduce your taxes or increase your taxes, depending on what type of corporation you create.

There are two main types of corporations: "C" Corporations and "S" Corporations -- and which type you choose can make all the difference in the world of taxes.

NOTE: The question of "C" Corp vs. "S" Corp has no effect on the asset protection provided by your corporation. This is a tax issue, not a legal issue.

A "C" Corporation can lead you into a Tax Trap known as "double taxation". Yes, income from a "C" Corporation can actually be taxed twice -- once when it's earned on the corporate level and again when it's paid to you, the shareholder, in dividends.

There are several ways to avoid double taxation. Often the easiest way is to tell the IRS that you choose to be an "S" Corp instead of a "C" Corp. The profits of an "S" Corp are not taxable to the corporation; instead, those profits are reported directly on the shareholder's personal income tax return and are therefore only taxed once.

And once is enough, don't you think!

Of course, any article on Choice of Entity must contain the old disclaimer, "Consult your tax professional" -- I am not prescribing a one-size-fits-all approach to this issue. But for many small biz owners and self-employed folks, the "S" Corporation is a good fit because it provides protection from personal liability and avoids the nasty tax trap of double taxation -- two great benefits worth checking into.

Should you incoporate your sole proprietorship and then decide that the "S" Corporation is the right fit, you must inform the IRS that your corporation is choosing "S" Corporation status by filing Form 2553, which is, in effect, an application to become an "S" Corporation.

IMPORTANT: If you incorporate and do not file Form 2553, you are automatically considered to be a "C" Corporation by the IRS. In other words, to be a "C" Corporation, you just incorporate; there is nothing you have to do to inform the IRS you want to be a "C" Corporation.

There are critical rules regarding how and when to file Form 2553, so be sure to read the instructions carefully, or check with your tax pro.

Failure to file Form 2553 on time or filing Form 2553 incorrectly results in a rejection of your corporation's "S" Corp application, and the corporation is then by default treated as a "C" Corp, subject to double taxation, the very trap you were trying to avoid.

To download a copy of Form 2553, go to:

The instructions for filing Form 2553 are found here:

Wayne M. Davies is author of 3 tax-slashing eBooks for the self-employed, available separately or as a 3-volume set, "The Ultimate Small Business Tax Reduction Guide".

To get your free copy of Wayne's 25-page report, "How To Instantly Double Your Deductions" visit:

In The News:

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Some traveling workers losing money from tax reform  WJHL-TV News Channel 11Congressional Republicans passed sweeping tax reform in 2017 with the goal of putting money back in the pockets of hard-working Americans.
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Ocasio-Cortez wants to raise the tax rate on high earners. The Tax Cuts and Jobs Act already did  Brookings InstitutionIn the 2017 Tax Cuts and Jobs Act, Republicans imposed a top tax rate between 60 to 70 percent on high-income corporate executives. Adam Looney argues ...
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Taking this step when filing your taxes can help you avoid a gross negligence penalty from the CRA  Financial PostJamie Golombek: Take the time to ensure you can back everything up with proper proof, or it could come back to bite you, as one taxpayer learned.
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How a salaried person with income up to Rs 7.75 lakh can now pay zero tax  Economic TimesGoing by the Budget 2019 proposals, a salaried individual with gross total income up to Rs 7.75 lakh can invest in various tax saving avenues and avail of ...
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GST Council defers decision on tax on real estate; extends deadline for sales returns  Economic TimesNew Delhi: The GST Council deferred a decision on rationalisation of tax rates for real estate and lotteries till February 24 when it will continue the discussion, ...
Opinion | Relief from angel tax will boost startup ecosystem  Moneycontrol.comThe government has tried to address most of the concerns of the startup community.
Government tweaks Startup definition, raises angel tax exemption limit. Check details  Times NowNow an entity will be considered as a Start-ups up to a period of ten years from the date of incorporation and registration. This period was earlier used to be 7 ...
EU offers lucrative tax breaks to firm of billionaire Brexiter  The GuardianJim Ratcliffe's Ineos has been granted support worth €178m from Germany and others.
Reporter's Take | Angels get a tax breather  Moneycontrol.comAlso, a company earning anything up to Rs 100 will be considered a start-up instead of the earlier limit of Rs 25 crore.
'A' Khatas for tax-paying properties, moolah for BBMP  Deccan HeraldAfter years of confusion, the Bruhat Bengaluru Mahanagara Palike (BBMP) is set to fully legalise all the 'B' Khata properties in its jurisdiction. This means any ...
Taxing the Wealthy Sounds Easy. It’s Not.  The New York TimesTwo Democrats have proposed taxing the richest Americans at a higher rate. But if past efforts to use tax policy to target one group are a guide, they can backfire.

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