Friday, November 12, 2010


It seems my announcement of THE SCHEDULE C LETTER has re-opened the online debate of “Should a Sole Proprietor Incorporate, or A One-Person LLC Elect To Be Taxed As A Corporation, For No Other Reason Than to Reduce the Chance of an IRS Audit?”

Here are the comments, the first from me, to the post “To C Or Not To C, That Is The Question” by Russ Fox at his blog TAXABLE TALK.


Thanks for mentioning my new THE SCHEDULE C LETTER, and for the recommendation.

I do agree that all sole proprietorships should register with the state as a one-person LLC for the limited liability protection – but I definitely do not believe that they should all, if possible, file as a corporation.

From my newsletter’s sample issue -

An LLC can elect to be taxed as a corporation - but if you want to be taxed as a corporation you should, in my opinion, actually incorporate the business activity.

There exist situations where it may be “more better” to operate your business as a corporation. The decision to incorporate takes very serious study and consideration. I suggest you consult with a tax professional – and not a lawyer – before making such an important decision. It is very important that you review the tax consequences of dissolving the corporation as well. Like a marriage – a corporation me be relatively inexpensive to get into, but very expensive to get out of!

And –

Do not overreact and incorporate your sole proprietorship, or elect to tax your one-person LLC as a corporation, solely for the reason of avoiding an audit.

The advice that one should incorporate solely to avoid an audit seems to me to be saying, ‘If you want to cheat on your taxes you can incorporate and the IRS will not audit you’. It is not good tax or financial advice. Be wary of so-called professionals who give this advice – they may be more interested in boosting their fees than in providing you with good advice.

I have said time and again that an IRS audit is not something that should be avoided at all costs. Tax returns should be prepared, and decisions about choosing a business entity should be made, in such a manner as to generate the absolute least amount of federal, state and local taxes (income and payroll) within the parameters of federal and state laws. If you will pay less tax (income and payroll), fees and other costs by filing a Schedule C you should do so, honestly and ethically, and not worry about being audited.

If your return is prepared correctly, and you document all items of income and deduction properly upfront, then an audit is nothing more than an inconvenience

I might also add that filing as a corporation has the potential for a lot of unnecessary agita for a small business sole proprietor.

Thanks again for the plug and for your confidence in my competence as a tax advisor.”


Russ replied –

“I don’t have much to add to what you wrote. I strongly believe that entity formation has three components: tax, legal, and the goals of the owner(s). What is correct for one person may not be correct for a second person. Anyone starting a new business needs to consult both a tax professional and an attorney.”

To which I responded –


I do agree – but consult the tax professional first, and discuss what the lawyer had to say with the tax professional before taking any action.”

Russ does make a good point – “What is correct for one person may not be correct for a second person”. To say that all sole proprietors should either incorporate or, if an LLC, elect to file as a corporation PERIOD is, as I said above, very bad advice.

Does incorporating, or filing as a corporation, reduce the likelihood of an IRS audit? Yes. But this is only one aspect of the decision, and a very minor one at that. Are all Schedule Cs audited, or will they be? Of course not!

Operating or filing as a corporation has the potential for much more unnecessary agita and increased costs (taxes and, especially, professional fees) and paperwork than any audit!

So what do my fellow tax professionals and tax bloggers think?



Peter Reilly said...

Once somebody incorporates they have to decided whether to make an S election to avoid possibility of double taxation. The basis rules of an S corporation yield different, and usually worse results than a partnership or disregarded entity. It is a regular theme of tax court decisions that I find.

Online Tax Advice said...

"An LLC can elect to be taxed as a corporation - but if you want to be taxed as a corporation you should, in my opinion, actually incorporate the business activity."

When we talk about private company formation most of the times we came to know that there should be minimum two members in a private company what does it mean that now company is registered and is payable for tax but rules and regulations vary from region to region.