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Should You Incorporate?

by Daniel Steven

As a freelance writer or author, you may wonder about the benefits of incorporating.  You’ve probably seen the ads in writer’s magazines and on the web:  “Incorporate Your Business for $31.00!”  The claims are astounding: incorporating will protect you from creditors, lower your taxes, pay for fringe benefits, instill financial discipline, get new clients, and cook your breakfast.

Well, not quite.  There are advantages to incorporating, especially if your writing income is in six figures, or if you need to limit your personal exposure to lawsuits.  But incorporating also can be expensive and ineffective.

First, let’s distinguish between types of corporations. For tax purposes, individuals can incorporate either as a “C” corporation or an “S” corporation.  A C corporation is a regular corporation; an S Corporation is a regular corporation that has elected “S” corporation status.  An S corporation lets you enjoy the limited liability of a corporate shareholder but pay income taxes on the same basis as a sole proprietor or a partner.  Recently, the popularity of S corporations has waned as limited liability companies (LLCs) have largely replaced them.  (An LLC is essentially a partnership with the advantage of a corporation's limited shareholder liability, even if the owners participate in the management of the company.)

Now let’s look at the claims -- and the reality:

1.  Income taxes on money not removed from the corporation.  If you choose a C corporation, corporate tax rates are lower than the personal tax rates you likely are paying as a sole proprietor. When you eventually withdraw corporate profits as stock dividends, however, there is a double taxation: it is taxed again at your personal tax rate.  If you retain too much money in your corporation to avoid this double taxation – or for future investment - the IRS can force you to withdraw it, pay the dividend tax, and even assess a penalty.  The S corporation, by contrast, “passes through” all income to the shareholder, thus eliminating double taxation entirely, but you cannot retain earnings in your corporate account for future use. 

2.  Employment taxes.  There is no corporate advantage here.  When you pay yourself a salary from a corporation, the corporate FICA and Medicare tax contribution, plus the employee’s FICA and Medicare tax contribution, are roughly equal to the self-employment tax of 15.3%. 

3.  Fringe benefits.  A C corporation may deduct from income the cost of paying your medical insurance premiums and medical cost reimbursements; it also may deduct the cost of providing employee’s disability insurance (but then any benefits paid to you are taxable); and it can deduct the cost of an employee’s life insurance policy up to $50,000 coverage.  Until recently, this health insurance premium deductibility was a major corporate advantage; in 2003, however, self-employed persons also may deduct 100% of health insurance premiums.  An S Corporation doesn’t provide all the corporate advantages – there is lesser deductibility of medical expenses, no life and disability insurance deduction, and lesser deductibility of retirement plan contributions.

4.  Pension plans.  Both self-employed individuals and corporations may set up retirement plans; a C corporation, however, can establish a retirement plan allowing higher contributions and may allow participants to borrow from the plan for such purposes as buying a house.

5.  Other business deductions.  With the exceptions noted above for fringe benefits, a sole proprietor filing a Schedule C on Form 1040 can deduct the same business expenses as a corporation – office expenses, rent, equipment purchases, etc. 

6.  Fees and Paperwork.  Even if you don't use a lawyer, there are initial and annual fees to the state where you incorporate. Your state also may impose a minimum tax on corporations, no matter how much (or how little) income you have – in the District of Columbia, for example, the minimum annual tax is $100.  In some states, it can range as high as $800 or more. You’ll have to file annual reports and minutes.   You also can count on a larger bill from your accountant for the increased paperwork.

7. Limited Liability.   Incorporation will protect you personally from creditor’s claims against the corporation.  Freelance writers, however, rarely accumulate much business debt – and most lenders will require that you personally guarantee the payment of a corporate loan in the event of a corporate default or bankruptcy.  Likewise, publishers routinely require authors to personally pay the publisher in the event of a defamation or copyright infringement claim resulting from the author’s writing.  Further, if you run the corporation essentially as a sole proprietorship, a plaintiff might be able to “pierce the corporate veil” and make you personally responsible regardless of your corporate status.  Finally, a corporation is not immune from your personal debts: if someone gets a judgment against you, they can acquire your corporate stock just like any other asset you own, then sell the corporate assets. 

In summary, there are tax and fringe benefits to be gained by incorporating as a C Corporation, especially if you generate high income and can afford expensive benefits and high pension contributions.  Likewise, if you self-publish or write high-risk freelance articles such as celebrity profiles, the limited liability of the corporate entity is useful.   Incorporating as an S corporation provides only the benefit of limited liability; if you are only looking for this advantage, a limited liability company (LLC) has greater flexibility and is generally a better choice, at least in those states that allow single-member LLCs.

The advantages of incorporation must be weighed against the possibility of double taxation, higher legal and accounting fees, and additional paperwork.  Further, corporate limited liability for writers, as noted above, is somewhat illusory.  In general, most freelance writers are usually better served worrying about finding new clients or finishing the next book rather than incorporating.

© Daniel Steven 2002

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