subject: Small Business Tax Trap #1: Waiting To Incorporate -- What A Difference A Date Can Make by:Wayne M. Davies [print this page]

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If you're a sole proprietor, perhaps you've considered

incorporating your small business or self-employment

activity.

And so maybe you've been wondering,

"When is the best time to incorporate?"

>From a legal standpoint, any time is the best time.

The sooner you incorporate, the sooner you make the move

from the world of unlimited liability to the world of

limited liability.

>From a tax savings standpoint, any time is the best time.

The sooner you incorporate, the sooner you will start

putting more money in your own pocket and less in

Uncle Sam's.

(For more about the potential tax savings of a

corporation, see the second article in this series --

"Tax Trap #2: Double Taxation -- Isn't Once Enough?"

http://www.YouSaveOnTaxes.com/tax-trap-2.html)

But from a **tax reporting** standpoint, there is one time

of year that stands out as best: January 1st.

Why is that?

Assuming you have a sole proprietorship (or other entity,

such as a partnership) that is up and running as of

January 1, and assuming you then incorporate that

existing entity on any date other than January 1,

you face the possibility of filing not one but

two business income tax returns for that year.

Here's an example to clarify this important point . . .

Let's say you've been operating your sole proprietorship

for a few years, and in early 2006 you decide to

incorporate. In January you get around to starting

the paperwork, but life gets in the way and

you finally get it done in late February. By the time

your state processes the Articles of Incorporation,

the start date of your new corporation is March 1.

For 2006, you must file a Schedule C for the period

of January 1 through February 28, when your business

was still a Sole Proprietorship. And you must also

file a corporate income tax return for March 1 through

December 31.

Maybe that's no big deal. Maybe you enjoy filing

one business income tax return so much, filing

a second one doesn't bother you. And it may be

that the inconvenience of filing two tax returns

in 2006 is far outweighed by the legal and tax

advantages of incorporating.

Keep in mind, too, that 2006 will be the only year

you have to do this "double duty". In 2007 you

will only have to file the corporate income tax return.

But if you are thinking about incorporating, the

best time to do it, from a tax paperwork standpoint,

is as of January 1. Only then do you have a "clean break"

from the old sole proprietorship to the new

corporation.

This timing issue can also be relevant if you

decide to make the switch late in the year. If

the effective date of the incorporation is November 15,

you will have to file a Schedule C for January 1

through November 14, and a corporate return for

November 15 through December 31. In that scenario,

you should ask yourself, "Do the benefits of

incorporating outweigh the convenience of waiting

until January 1?"

So before you decide when to incorporate, take a moment

to reflect on the tax reporting consequences of

incorporating on January 1 vs. any other date.

Sometimes it may make sense to wait a few weeks

(as in the second example), and sometimes it makes sense

to "do it now", especially when January 1 is nearby.

NOTE: This is the first in a series of 5 articles:

"Small Business Tax Traps and How To Avoid Them"

About the author

Wayne M. Davies is author of 3 tax-slashing ebooks for small business owners and the self-employed.

For a free copy of Wayne's 25-page report "How To Instantly Double Your Deductions" visit

http://www.YouSaveOnTaxes.com.

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