Now let's move the complexity of our tax strategy up by a notch -- we will be discussing forming a full company, also known as the C corporation (as compared to S corporation with simplified tax treatment). C corporation files its independent tax return, and can distribute its earnings to shareholders via dividends or capital gains (like any publicly traded company).

One common (perceived) drawback of a C corporation is that it will get business owners double-taxed. Yes, it is usually the case when you purchase a stock -- the company will be taxed at the corporate level, and shareholders will be taxed (again) thru dividend tax or capital gains tax. However, double taxation is not that bad for those self-employed who form a C corporation.

First thing first, owner-employees of C corporations have more than one ways to extract the money without getting double-taxed. For example:

• Employee compensation (to a reasonable extent): You will be taxed at the individual level plus FICA tax (including company's share too). However, at corporate level, you can deduct all these. Therefore, if you can distribute all your corporate pro forma earnings back to yourself as compensation, you will not be taxed more than if you were running your business as a sole proprietorship.

• Interest payments: You can lend some money to the company, and the interest company pays back to you will be taxed at your individual tax bracket (without FICA tax) while company can deduct the payment as business expense. (Similar treatment for royalty payments and lease payments.)

• Retirement plan contribution: To the extent that you can shield majority of your income in retirement plans like individual 401(k), double-taxation for C corporation does not matter.

Now let's see how C corporation can actually improve your situation:

• A different set of tax brackets will apply at the corporate level. For example, the first $50,000 of corporate profit will be taxed at 15%. What it means is for people in high individual tax brackets, they will be better off getting double taxed. Here comes the math (assuming your individual marginal tax rate is 25%):

Alternative #1: If you recognize the profit at the company level, and take dividends from the company, for even $10,000 of pre-tax company profit, $1,500 will be used to pay corporate income tax, $8,500 * 25% = $2,125 will be used to pay for individual income tax, leaving $6,375 in your pocket.

Alternative #2: You take the $10,000 as self-employment income (without forming a business, or as LLC or S corporation), you will pay 25% for federal income tax, and 15.3% for self employment tax. Total tax will be $1,530 for self employment tax, 25% * ($10,000 - $765) = $2,309 for individual income tax, netting you only $6,161.

• C corporation is allowed to deduct, up to certain limits, fringe benefits like medical insurance and life insurance. Plus, you can set up your own flexible spending account at the corporate level, so your dependent care bill can be tax-free too.

• Unlike S corporation or LLC, which should use calendar year as the tax year in most cases, C corporation can pick its own tax year. This definitely allows you to manage your income between the corporate tax return and individual tax returns. With a C corporation, you probably no longer have to play the trick like prepaying your January mortgage bill in December to save a few dollars.

• By keeping a good chunk of income away from your individual tax returns, you can dial down your AGI, which determines your eligibility for certain tax benefits like Roth IRA, Coverdell Education Savings Account, Child Credit, etc.

(A note for the self-employed: make sure you understand whether your business will be classified as a "Personal Service Company." If that's the case, your business will be subject to a flat 35% income tax, which will remove some of the benefits we discussed above.)

All in all, if used wisely, C company can be a great tool for tax planning. Isn't it?

This post is part of the Tax Strategy for Self-Employment Income Series, please also read the rest of the series:

Part 1: The Tax Exposure
Part 2: The Framework
Part 3: The Major Options
Part 4: Individual 401(k) Introduction
Part 5: Individual 401(k) Analysis & Resources
Part 6: SEP IRA and SIMPLE Plans
Part 7: Forms of Doing Business
Part 8: LLC and S Corporation
Part 9: C Corporation
Part 10: The Conclusion