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Q: Taxes and Incorporating ( Answered,   3 Comments )
Subject: Taxes and Incorporating
Category: Business and Money > Accounting
Asked by: onetwo-ga
List Price: $10.00
Posted: 11 Oct 2006 22:10 PDT
Expires: 10 Nov 2006 21:10 PST
Question ID: 772851
Late August of this year I built a website to earn money.

I?m a young guy. I graduated high school but never any college. I
never was educated by anyone about taxes. I have no idea about
incorporation or taxes or anything related.

[+] With only about 10 customers averaging between $500 and $7,000
I?ve earned roughly under $20,000 via online sales in the past three
months. I am NOT incorporated. Most of the online sales came via
credit card through PayPal.
** as I reread this I would like to make a side note that nothing I am
doing is illegal and I have nothing to hide **

As most of the money came from PayPal, and is directly deposited into
my bank account it, essentially goes unaccounted for. And is almost as
if it just "appeared".

[+] A $2,400 check was actually made out to my company name (mistake
by the customer) I went to my bank to deposit it and they actually
accepted it. It took a little bit of coaxing on my part but anyway the
check was definitely made out to the company name which doesn?t sound
anything like my name and they accepted it.

[+] A $3,500 check is on it?s way now, and another one will be on it?s
way within the next month or so. They are both made out to my name.
The company called and asked for my social security number to send an
?A9? form? Or some form that I can submit for taxes.

[+] I am sure the $2,400 check will be reported to the IRS as an
expense. I have no idea if it will trace back to me because I have no
idea how these things works.
[+] I am sure the two (2) $3,500 checks will be reported as well
(because the accountant called and asked for my social).
[+]I know other companies are going to be writing off the money they
sent to me as a business expense.

What do I do?

[+] Do I really need to incorporate, or can I continue doing business as it stands.
What are the advantages and disadvantages of incorporation? 
And of all the types of incorporation, what would be the one you would
most suggest for my needs?

[+]Technically, I can incorporate in any state that I would like to,
as long as I have a mailing address in that state?
[+] In which state would I incorporate to pay the least taxes?

[+] I understand that a portion of the income I need to present to the IRS by law.
What portion of the income would be less noticed if I couldn?t report
it on my taxes?
Subject: Re: Taxes and Incorporating
Answered By: keystroke-ga on 12 Oct 2006 06:50 PDT
Hello onetwo,

Thank you for your question.

You don't have to incorporate at all. You don't even have to
incorporate in order to take money off your income taxes for business
expenses. You can operate as a sole proprietor, and in fact, you
already ARE a sole proprietorship simply by conducting business by
yourself. You can say that you are "Jane Rain dba (doing business as)
Fundamental Sports Company" or whatever your business is called.

However, you do need to report all the money that you're making to the
IRS.  I'm making the assumption that you are a US citizen. As a US
citizen, you are required to report all worldwide income made to the
IRS. The money did not just "appear." Paypal can report that money to
the IRS and certainly has it on record going to your email address.
Your account with Paypal is certainly not anonymous, and if you
continue making so much money, this will become a huge task to "hide"
this money in your bank account and could have huge consequences for
you later. Some more information can be seen here:

Taxes on Ebay

If Paypal doesn't report now, they certainly could start reporting and
remember that they will still have all those records. Years and years
of you making $100,000 a year tax-free will get you prison time for
tax evasion.

Reporting Paypal Income

"Don't think that just because PayPal doesn't report to the IRS now
that you're safe. When they do start reporting, the IRS could ask for
back records and they could come after you for back taxes, fines,
penalties and interest. Not fun."

You were issued a W2 form to fill out for the IRS.

A Google Answers Researcher cannot advise a person to do anything
illegal. You must report your taxes properly or you will be setting
yourself up for worse problems in the end.  In most states, you will
need to pay a 15 percent self-employment tax (for Social Security and
Medicare) in addition to the income tax rates for whatever bracket
you're in. Your income from the business would be counted in this.

I suggest that you do this the right way: operate as a sole
proprietorship, open a business account (many banks allow you to open
them for free), pay taxes, and also deduct business expenses (such as
the operating of the website or leasing of office space) off your

Here is a Google Groups search thread to look through on what a sole
proprietorship means:

Sole Proprietorship Search Results

Why should you not incorporate? Incorporation holds no appeal for
someone who is doing business on their own. There is no liability that
a person wouldn't have with a corporation or LLC that they would have
with a proprietorship. Someone can still sue you if they want. You are
still liable for the debts of the business as a corporation, in most
cases, and you pay money to the state in fees and time spent filling
out papers.  There are no advantages that I see for your situation.

Search terms:
reporting paypal income taxes
sole proprietorship

If you need any additional clarification of my answer before rating,
let me know and I'll be glad to help.


Request for Answer Clarification by onetwo-ga on 12 Oct 2006 11:21 PDT

Thank you for your answer. Although lengthily, it still leaves a lot
of open ended answers and focuses the majority on the subject "Yes,
you should report your income to the IRS." I am aware that I should
report my income to the IRS and I very much appreciate your advice.

Here are a few open ended answers that I am looking for clarification regarding;
What are the differences in income tax one would pay between a SOLEP,
LLC, or DBA assuming the scenario of a $120,000/annual income. In
which state would those taxes be least?

Also, you mentioned that if I did NOT incorporate, I would be imposed
a 15% "Self Employment" fee as stated here;
"In most states, you will need to pay a 15 percent self-employment tax
(for Social Security and Medicare) in addition to the income tax rates
for whatever bracket
you're in"
Which states impose that tax and which do not? Also, what would be the
defining criteria of which state I would belong to. My HOME address,
or the official address of my company?

Please be advised I am not looking for information how to evade taxes,
but limit them to a minimum.

Clarification of Answer by keystroke-ga on 12 Oct 2006 22:09 PDT
Hello onetwo,

Thank you for asking for clarification. You would pay about the same
amount of taxes in any of the cases. LLCs and S-corps "pass through"
your bank account, which means that they would all be considered
income and you would have income of $120,000 a year. With a C-corp,
you get taxed twice-- the company is taxed separately, then you are
taxed on your profits. This can be gotten around. You could hire
yourself as an employee, pay yourself a reasonable wage, which may be
$120,000, and then only pay taxes on your personal income, since the
business technically makes no profit. Here are some previous questions
that I have answered that might help you with this situation:

"LLC or C Corp or S Corp?"


"paper work and business expense deduction for sole proprietor in California"

You are basically going to always be paying the same amount of taxes.
There is no state where you will pay less taxes, unless you live in a
state that has no income tax. If you don't live in a state that has no
income tax, you can't incorporate in a state that has no income tax
and expect to pay none, because you'll still have to file taxes in
your home state and pay income taxes there. What it comes down to is
this: if you decide to incorporate for any reason, do not choose
Nevada or Delaware. Choose your own state and save yourself time and
trouble. If you file in another state, you'll have to file in your own
state as a foreign corporation, costing time and money and probably
negating any benefit. Many people think that an internet business has
no home base and can be from any state. This is not true. Where do you
have your house? Where is your bank account? That is your state. You
must pay taxes in that state. Don't complicate it by making it so that
you have to pay taxes in two different states.

The self-employment tax, which is skillfully elaborated on by the
commenter vegasfyr-ga, is a federal tax (Social Security and Medicare)
and will be imposed no matter where you live.  If I said that some
states did not impose it, I believe I was wrong on that count. Some
states do not impose a self-employment tax on LLCs and some do. That
is what I was thinking of. (But the ones who don't charge a
self-employment tax charge other taxes to make up for it; they get you
coming or going. There is no magic state with less taxes.) This is
elaborated on in my other Answers above.

Are your offical address and the address of your company in different
states? If so, if you are doing business at your home as well as at
the company, you would have to incorporate in both and register as a
foreign corporation in one. If you only do work at your company's
address, then that's the state it should be located in.

Vegasfyr-ga is also correct that you would need to abide by local
business laws and acquire a local or state business license if
required. You could even join the Chamber of Commerce if you wanted

Hope this helps a bit more.


Clarification of Answer by keystroke-ga on 13 Oct 2006 11:08 PDT
Abezon-ga makes some very good points. However, as far as the
liability issue goes, this is not true and not really an issue with
you because you are a sole owner of a business. If you had an S corp
or an LLC, even though that's "limited liability" you could certainly
still be personally sued (and lose your personal assets) for things
that occur in the business. You can also buy insurance as a sole
proprietorship that will protect you in case this happens. The
insurance would probably cost less than incorporating.

If you have employees in addition to yourself, that's when you are
taking on responsibility for other people's actions besides yourself
and need to be incorporated for liability purposes. A corporation
would "shield" you in that case, but you personally can never hide
behind a corporation. Example: Kenneth Lay. Perhaps not the best
example, but you get the idea. If you screw up, you're liable. LLC and
S-corp doesn't prevent that.

If you have a corporation and get sued, then you will simply have both
yourself and the corporation sued for the wrongdoing. And your house
very well could be taken if you are found guilty of gross personal
negligence. For business debts, however, incorporation would shield
you to a certain extent from business creditors.

From Google Groups:

"An LLC protects you from _contract_ liability.  If you get in over
your head, and your business expenses exceed your business sales over
a period of time, you can dissolve the LLC and walk away from those

An LLC does *not* protect you from tort liability.  You are *always*
responsible for the things you did that you shoudn't've and the things
you should've done that you didn't do."

"Actually, they would usually sue both the LLC and the person who
gave the bad advice/made the libelous statements.  *If* they win,
they'll collect from whichever has assets to collect from.

An LLC doesn't protect you from your own negligence/malpractice/etc.
any more than it protects you from, e.g., screwing up while driving a
car and somebody gets hurt.  If it's a "company car," then the company
and the driver are _both_ liable."

The only way to truly protect your assets, such as your house, is
through tort liability insurance.

Subject: Re: Taxes and Incorporating
From: vegasfyr-ga on 12 Oct 2006 11:53 PDT
You still have to pay taxes - if you incorporate, then the corporation
pays taxes on the (net of expenses) money it makes, AND you pay taxes
on the money you take out, whether as a salary or a dividend. If you
LLC, DBA, etc, you pay taxes on the money you make.

Self employment tax. You pay this regardless, it is just called
different names. If you incorporate and pay yourself a salary, 7.65%
is withheld from your check and sent to the IRS by your company, and
7.65% is paid by the company for a total of 15.3% for social security
and medicare. If you are a sole proprietor (DBA), you pay 15.3% of
your income for social security and medicare, but it is called "self
employment tax". This is the part that will get you - screwing up your
employment tax. You will owe it, they will take it. And penalties and
interest will run you more than 10% a year. On 100,000, look to pay
15K in taxes, and 1500 a year for not reporting it. You file state
returns based on where you live.

All states charge additional fees to incorporate - annual list of
officers, filing fees, etc. This is why keystroke advised you not to
incorporate. You will merely take on additional fees, and the
corporation will file a tax return (costs money), you will file a tax
return (costs money).

For $10.00, you probably won't get extensive tax planning and legal
advice (which is what you are asking for). If you are going to make
that much money, get an accountant/bookkeeper in your town. Many offer
free consultations, and you will need one anyway to prepare your
taxes, if you are going to be earning this kind of money on a small
business/self employed set up. Getting help now, setting up and
starting right from the beginning will save you money in the long run,
and a tax preprarer can help you plan accordingly, including how to
save for retirement (that is all deductible too.)

And, don't count on the companies just "expensing" your fees/sales
costs. If they send you money, they have to report any amount over
$600 to the IRS, or THEY get hit with fines and penalties. And as
keystroke said, the money didn't "appear". If (when) you are audited,
because you declare no income, and live in a zip code that requires
money to live (only one of the many flags they use), it will be
caught. Even a first time field agent couldn't miss it. "You have a
bank account, because the bank reports it to use. Let me see your bank
statements. OK, here is $20,000 in a three month period not reported."
See? Get a tax professional to help you with this. Set up a set of
books, declare your income and expense, and stay out of trouble early.

Subject: Re: Taxes and Incorporating
From: abezon-ga on 13 Oct 2006 10:10 PDT
A few more points: 
1. Your tax bill comes from 2 different types of taxes -- income taxes
and employment taxes. If you form an LLC or operate as a sole pro,
you'll pay employment taxes on all net profits. Since this is 15.3%,
it's a significant hit. On the $100k net profit mentioned above, your
SE tax would be about $15k. You'd also have income taxes on top of
that, & your total tax bill would be around $30,000. However, failing
to report all income so that your total tax is understated by 25% or
$5,000 leads to fraud penalties of _25%_ of the underreported amount.
Then the IRS would add penalties for underpayment on the tax & the
fraud penalty, + interest on both, which means your $30,000 tax debt
would double rather quickly.

In other words, report all income even if you think the IRS won't be
told about it. Trust me, the first thing the IRS looks at in an audit
is gross income.

2. Corp v. sole pro: Incorporating serves 2 purposes: first, you limit
your personal liability. If a corp is sued & loses, only the corp
assets can be grabbed to pay off the judgment. Your personal house is
safe. (This assumes you do everything properly & keep corp records,
buy corp insurance, etc. Read self-help legal books for more info.)
The second way a corp saves you money is that you can actually pay
less taxes if you operate as an S-corp. This is because an S-corp MUST
pay its officer-workers a "reasonable" wage. The corp must also
withhold $$ for employment & income taxes from each check & send it to
the IRS every quarter. The tax savings comes from the fact that any
profits that exceed the wage are NOT subject to employment taxes (that
pesky 15.3%). The extra profits are still subject to income taxes, but
you save the SE taxes.

The biggest audit inquiry here is whether you paid yourself a
reasonable wage. You have to look at what workers in the industry
would get paid & pay yourself at least that much. On $120,000 of
income, the net profit might be $80,000 & a reasonable wage might be
$40,000. Thus, paying yourself a wage saves you employment taxes on
$40,000 of income, which translates to over $6,000 less you have to
send the gov't.

To do this, you have to either form a corporation & file an election
with the IRS to be taxed as an S-corp, or you form an LLC & elect to
be taxed as an S-corp. Either way, the corp/LLC has to file its own
tax return.

3. I strongly suggest you talk to a tax pro about what records you
need to keep & what expenses you can deduct. You should also be saving
about 30% of your gross sales for the whopping big tax bill you're
going to have in April. This assumes you have a 'pure profit' type
business. If you have significant expenses or have to buy your own
inventory, talk to the tax pro about how much to save.

Good luck on your business.
Subject: Re: Taxes and Incorporating
From: vegasfyr-ga on 13 Oct 2006 14:06 PDT
For the "avoiding the self-employment tax." It is important to note
(this is often difficult for people in favor of raising taxes to
grasp), you do not "avoid" the taxes by incorporating. The business
still has to pay 7.65% of your wages to the IRS as employee tax, and
7.65 is still withheld from your check to send to the IRS, meaning the
company (YOU) still have to send the IRS 15.3% of the money you make.
If you leave it in the business, you merely delay the payment - when
you take it out, you will pay tax on the money.

NO TAXES ARE PAID BY BUSINESS!! All taxes are paid by people -
businesses merely pass any tax increase on to the customers in the
form of higher prices.

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