1. Protect yourself from personal liability

• Corporation or LLC signs lease – you’re not personally liable
• Corporation or LLC borrows money – you’re not personally liable
• Corporation or LLC buys goods and services on credit – you’re not personally liable

2. Business Tax Deductions

According to Judge Learned Hand, “any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes. Gregory v. Helvering, 69 F.2d 809 (2nd Cir., 1934).” Furthermore, the Supreme Court stated that “[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.” Gregory v. Helvering, 293 U.S. 465 (1935).

Entrepreneurs will want to attribute as much of their expenses as possible to reasonable and necessary business expenses. Why pay more taxes than necessary? Many taxpayers overlook legitimate deductions for business expenses. To the extent possible, entrepreneurs will want to ensure to deduct the following business expenses:

• Vehicle expenses are deductible if they are attributable to a business use. An individual taxpayer cannot claim a corporate expense, it is an expense of the corporation. Automobile lease payments are deductible if they are ordinary and necessary expenses of a trade or business directly attributable to the operation of a trade or business.
• Travel expenses are deductible to the extent they are reasonable and necessary expenses incurred in the conduct of a trade or business directly attributable to the trade or business. Townsend Industries, Inc. v. U.S., 342 F.3d 890 (8th Cir. 2003). Thus, a corporation could hold an annual meeting for its shareholders and directors in a distant city.
• Start-up and organizational costs, at the taxpayer’s election, may be treated as deferred expenses and allowed as deductions prorated equally over a period of not less than 60 months, beginning with the month in which the active trade or business, corporation, or partnership begins.
• Certain types of entertainment expenses may be deducted, such as food and beverages provided for employees on the business premises, recreational expenses for employees, expenses of certain business meetings, and items sold or made available to the public.
• Attorneys’ fees, court costs, and other legal and accounting expenses may qualify as ordinary and necessary trade or business expenses.
• Rent for the use of property to which the corporation has no title and in which the corporation has no equity can be deducted as a trade or business expense if the rent is paid in connection with the corporation’s trade or business, is ordinary and necessary, and is paid or incurred during the taxable year. If the property on which the rent is paid is used for both business and personal purposes, only the portion allocable to business use is deductible. If the corporation leases office space at the residence of an officer or director, for the rent to be deductible the office space must be exclusively used for business purposes on a regular basis and be the principal place of business of the corporation.
• Expenditures for incidental repairs, maintenance, replacement, and improvements may be deducted as ordinary and necessary business expenses.
• The cost of materials and supplies used in a corporation’s trade or business generally is a deductible business expense.
• Interest and other borrowing charges incurred in the course of a trade or business are deductible.
• In general, state local and sales taxes that are ordinary and necessary corporation expenses paid or incurred in carrying on the trade or business are deductible.
• Salaries and other compensation for personal services actually rendered may be deducted as an ordinary and necessary trade or business expense. To be deductible, compensation payments must be reasonable and must be actually paid as compensation (rather than as dividends).
• The cost of insurance may be deducted as a business expense if the insurance is connected with the corporation’s trade, business, or profession
• Advertising costs related to a corporation’s business generally are deductible as an ordinary and necessary business expense.
• A rebate of a portion of the purchase price to a customer generally is deductible as a business expense.
• Payments to charitable organizations that bear a direct relationship to the corporation’s business and that are made with the reasonable expectation of a financial return commensurate with the amount of the donation may be deductible as business expenses. For example, a retail store might set aside a percentage of its sales for donation to local charities as part of a promotional campaign and thus be entitled to a business deduction for the donations.
• Setting up a reserve account can create a legitimate tax deduction. Midas Muffler warrants its muffler for as long as the purchaser owns the vehicle on which the muffler has been installed. If the muffler fails to perform properly during the warranty period, Midas will install a new, warranted muffler on the vehicle, and the muffler owner will not be charged for the muffler, only for the labor required to install. You may be interested to know Midas Inc. (the muffler company) recorded $38.5 million in charges to reflect its estimated liability associated with outstanding warranties in the U.S. and Canada. On a going forward basis, Midas will accrue for the expected future cost of warranty redemptions at the time of the original installation of the warranted part. See Midas Inc.’s 10-K here. What does this mean? Midas is claiming such warranty reserves as a business deduction! Other entrepreneurs are bound to take note and offer long-term warranties for their products and claim a business deduction.

3. Minimize IRS Audits

• Sole proprietors must file an IRS Form 1040, Schedule C (Profit or Loss from a Business). Unfortunately, the IRS audits sole proprietors that file the form at a higher audit rate than returns for an incorporated micro business. Also, sole proprietors with home office deductions face even more risk of audit by filing the IRS Form 8829 (Expenses for Business Use of Your Home) for home office deductions. S or C corporations avoid such scrutiny. See Shelter Your Small Business from Tax Audits.

4. Privacy

• The Corporation or LLC can be established in such a way so that shareholder/owners remain anonymous, many times the same anonymity can be accomplished for officers and directors.

5. Use of a Marketing framework

• Hold the business out to all as a Corporation or LLC
• Give the business the appearance of being much bigger than it is
• Attract investors more easily

6. Raising capital

• Because of the ease of transfer of ownership and the “separate entity” concept of the Corporation or LLC, it is much easier to attract investors than otherwise.

7. Easy transfer of ownership

• Put real estate in Corporation or LLC and transfer through private agreement, i.e. stock transfer rather than formal real estate transfer and closing.
• Re-title asset to a Corporation or LLC yet continue to maintain control.