FORM YOUR OWN CORPORATION There have been some full-page ads in magazines promoting ordinary corporations as the "ultimate tax shelter." It may not be the "ultimate" but by forming a corporation one can reduce taxes substantially. Here is how the tax reduction features of your own corporation would work. A corporation is considered a "legal person," just like a human being. But corporate incomes are taxed at a different rate than those of individuals. The obvious logic is that if you are a self- employed plumber, you can form a corporation to handle the retail pipe sales (or some segment of your business earnings). Presto, your tax is lower. To eliminate taxes entirely, you can then use the accumulated income in the corporation to contribute to a variety of allowable "tax-free fringe benefits" for you, your employees and your family. These include health insurance, pension plans, company cars, group life insurance, educational programs, and so on. Only owners of corporations can provide these tax-free to themselves and their employees. If there is any money left after the fringe benefits, the corporation pays a tax on remaining net profits at the low corporate tax rate. One can also look around for existing corporations in similar businesses who have large tax loss carry-forwards. You can totally shelter your corporation's earnings with the carried-forward losses of an unrelated entity, a "shell corporation" you purchased from someone else and merged into your corporation. A merger is a legal process in which two corporations become one corporation, with all of the assets and liabilities of both being the property of the remaining corporation. Through this process the tax loss of the other corporation becomes the property of your corporation. An individual can't create tax losses like that either. The main disadvantages of incorporating are: 1. It costs money. Though you can do it yourself for $50 to $75 (in most states. A few states are much higher.), an incorporating service will do it and provide you with a registered office for under $100 per year. There are also minimum annual state fees, though these can be kept to under $100 per year in most states. 2. If you are an employee of your own corporation, the Social Security tax will amount to about double what you would pay if you are self- employed. But the increased cost of Social Security can be avoided by making sure the corporation doesn't pay you anything but director's fees, fringe benefits, reimbursements for expenses, and dividends. None of these are subject to Social Security. If no salary or wages are taken you can actually use a corporation to totally avoid Social Security taxes. 3. The double taxation feature: The corporation pays income tax on its earnings, but when these earnings are paid out to you as salary or dividends, you are taxed on the distributions as unearned investment income at your individual income tax rate. Moral: You can't form a corporation and expect to save taxes by just passing cash through it. You do save taxes if you set up fringe benefit plans or if you want to use accumulated profits taxed at the lower corporate tax rate to expand or wheel and deal. Generally corporations help the self-employed or professional, but are not of much use to real estate investors, who get a much better deal without them. Everything you need to know about corporations (and a little bit more...) To understand what a corporation is, lets start at the beginning. We had Merrie Old England, with a king and knights, and life was filled with many of the same events still going on today. There were births, marriages, deaths. There were storekeepers, butchers, bakers, and candlestick makers. But there were no corporations, because none were needed. Then one day some explorers discovered Africa, India, America and a few other little places -- and it wasn't long before many people realized that a lot of money could be made by establishing plantations, settlements, and large scale industrial enterprises. But few people in those days had enough money to own more than a few merchant ships. Even kings and queens didn't have enough capital to start and maintain mines, ranches and so on 10,000 miles from home. Early corporations were always chartered by the sovereign or king to engage in trading, exploitation of mineral deposits, or other business activity that required more money and personnel than the normal sole proprietorship or small partnership. From the start, the general public was offered an opportunity to invest in "shares" of the corporation. In England, all corporations ended their name with the word "Limited" or "Ltd." to distinguish them from partnerships or sole proprietorships in which the owners were personally liable if anything went wrong. The new form of enterprise, the corporation, was liable for damages due to negligence, failure to perform a contract, etc. -- but only up to the assets of the corporation. Liability for the officers and shareholders was LIMITED. The concept of limited liability was, and still is, an important consideration. Another feature of the corporation was its perpetual life. Officers could die, retire, resign or be fired -- but the shareholders would elect directors every year. The directors would appoint the officers, and the officers would run the company -- forever! The Hudson Bay Company, Ltd. was started about 400 years ago and it still runs trading posts in Canada. As might be expected, they are called department stores these days. When shareholders die, their heirs inherit the shares. Some corporations made a lot of money for their shareholders. Others went into bankruptcy. Things got more complicated over the years, but the basic idea was always the same: any individual could apply to the government (any government) for a corporate charter. With the application, the promoter of the corporation- to-be submitted a plan telling the government what sort of business he intended to go into, how many shares he intended to sell, and where a representative of the corporation could be found. This form of application to start a corporation is called the articles of incorporation. Today, a charter is issued as a matter of course to all applicants who pay a small incorporation fee to the state. For free information on a national service that can form a corporation for you in any state, write to Incorporation Information Package, 818 Washington Street, Wilmington DE 19801. In many states a corporation can be a one man (or woman) operation. Usually one person can be the president, secretary (who keeps the records) and treasurer (who signs the checks). That same person can be the only director, and the only shareholder. A resolution is required when your corporation does something like enter into a major contract, open a bank account, or give you the tax free fringe benefits already mentioned. A resolution is simply a written statement in the corporation's official record book, making a decision the official act of the corporation. It is signed by the president and the secretary, and often copies of it will be required for things like opening a bank account. (Most banks will provide you with a copy of the form of resolution required by their bank.) For instance, if you are going to buy yourself a car, your corporate resolution should make it clear that the car is being purchased by the corporation, in the corporate name, and is to be used for business purposes only. If your company is going to adopt a plan to pay all your medical bills, health insurance, life insurance or educational expenses, the IRS requires some formalities. To get the federal tax advantages of a corporation you are expected to actually have documented shareholders and director's meetings -- even if just you are involved. This is called observing the formalities of the corporate form. Receipts and disbursements are expected to be transmitted in and out of the company checking account. As an employee of a corporation you can, by resolution, set up a pension plan. Into this plan you can deposit part of what the corporation pays you. The deposit into the pension plan (which is just another bank account) is deductible to the corporation, but not taxable to you until you take it out. You can invest the pension fund, put your best deals in the pension fund, and make millions in capital gains, interest, and dividends -- all accumulating tax free until you close out the pension fund. All profits made by the pension fund are tax free.