Tax Traps To Avoid When Incorporating a Business

As a general rule, you can incorporate your$15,000 bank loan and none of the loan has yet
business with no tax cost as long as youbeen paid off, the liabilities exceed the adjusted
contribute all of your business's assets and liabilitiesbasis of the truck by $15,000. In this case,
to a corporation you control.A sole proprietor whoincorporating triggers a $15,000 gain.
incorporates his or her business, therefore, shouldOuch.Incorporation Tax Trap #3: Lack of
be able to incorporate tax-free. So should aControlOne other thing. You need to be in control
partnership. And a limited liability company thatof the business after you incorporate.Often,
makes an election to be treated as a Ccontrol should not be a problem. If a sole
corporation or as an S corporation should also beproprietor incorporates her business, becoming a
able to make these "incorporation" electionsone-woman corporation, she's obviously still in
tax-free.But all rules, including general rules, can becontrol.If a three-man partnership incorporates
broken. And when it comes to incorporating yourand after the incorporation, the business still has
business, three big tax traps await unwaryonly the same three owners, the old partners still
business owners, managers andcontrol the new business. So, again, no problem.In
entrepreneurs.Incorporation Tax Trap #1: Goofysituations where an incorporation means new
LiabilitiesIf a shareholder transfers liabilities to aowners are brought into the business, you need
newly minted corporation and there's no businessto measure whether the old owners own 80% of
purpose to support all of the transfers or if theall the corporate stock in the new entity. If they
liabilities are transferred to avoid taxes, then alldo, no problem. If they don't, big problem: The
the transferred liabilities are treated as boot. Andincorporation is treated as if the old owners sold
that can be a disaster because the boot can bethe old business's assets to the new corporation
taxed.In general, liabilities incurred in the normalfor the fair market value of the stock received. If
course of a business's activities should easily passthe adjusted basis of those assets is less than
the "business purpose" and "no tax avoidance"the fair market value of the stock, the
tests. But if you transfer personal liabilities to aincorporators will pay income taxes on the
corporation (like a personal credit card balance),difference.Closing CaveatsTwo closing caveats:
you're in trouble. Similarly, if you transfer businessIncorporating a partnership and particularly a
liabilities that were really used to fund personallimited liability company that's been treated as a
expenditures (like a business credit line drawnpartnership can create some tax complexities
down to pay for a daughter's college tuition),that are way, way beyond this short article.Also,
again, you're in trouble.Incorporation Tax Trap #2:the rules for incorporating a business in a tax-free
Excess LiabilitiesIf a shareholder contributes bothmanner are complicated if you'll later move pieces
assets and liabilities to the new corporation andof the business outside the US. For these
the liabilities exceed the shareholder's adjustedreasons, if your incorporation plans involve a
basis in the property-even if all the liabilities arepartnership or foreign operations, consult with a
legitimate business debts--the shareholderknowledgeable tax practitioner.LLC formation
recognizes gain on the excess of the liabilities overexpert & CPA Stephen L. Nelson is the author of
the adjusted basis. And this is another easy trapboth Quicken for Dummies and QuickBooks for
to fall into.For example, if your only business assetDummies and an adjunct tax professor for
is a truck you bought and completely wrote off,Golden Gate University's graduate tax school.
its basis is zero. If you financed the truck with a