Small business incorporation can make wonderful legal and tax sense. No argument.

But new entrepreneurs need to know that a handful of incorporation scams often ensnare small businesses. And that is truly unfortunate. Getting entangled in an incorporation scam always creates headaches, usually wastes money and may even cause you to inadvertently break the law.

Scam #1: Incorporating for Automatic Tax Deductions

The first incorporation scam? Incorporating because someone off-base consultant says incorporation turns personal expenses like cars and travel into business deductions.

The reality sandwich is this: Incorporation does not produce automatic tax savings, and incorporation does not convert personal expenses to tax deductions.

The general rule--which works for sole proprietorships, partnerships, regular corporations and S corporations--says that any ordinary and necessary business expense can be deducted. Personal expenses, in comparison, can not be deducted.

One related point should be made, too. The tax accounting rules for entities do differ. For example, sole proprietorships have some tax planning tricks that can sometimes make them the best entity choice. So do partnerships and corporations.

You definitely do want to consider the tax features of the various entity choices you have available. A regular C corporation or a Sub S corporation might be optimal for your business. Or perhaps a partnership might be best for you. You should consider all your options.

But incorporating a business for automatic extra tax deductions, well, that's really just a scam.

Scam #2: Incorporating in Nevada to Avoid Your State's Corporate Taxes

The second incorporation scam is incorporating in Nevada (or incorporating in some other no-corporate-taxes state) to avoid your state's taxes.

The Nevada incorporation scam promises naïve business owners that incorporating, say, a California business in Nevada will mean the business doesn't have to pay California state corporate income and franchise taxes. The scam sometimes also promises that the business owner will avoid having to pay personal state income taxes.

Anybody who suggests that this scam works is either an idiot or a criminal... or maybe both.

Two problems exist with the Nevada incorporation scam. Problem one is that if your Nevada corporation does business in, say, California, you still have to register your corporation with California. That registration means you will have to pay any state franchise taxes.

Problem two? If a corporation earns profits in a state, that state gets to tax those profits. If a Nevada corporation in actuality operates in California, for example, all of the profits are subject to California income taxes--regardless of where the corporation was formed.

The bottomline? Make sure you don't incorporate in some other state because you think that will let you avoid paying taxes to the state you actually live and work in. The incorporate-in-Nevada scam amounts to state tax evasion, pure and simple.

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