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