A lot of entrepreneurs actually stumble into their own businesses. Maybe your story is much the same: when you started working online, you didn’t think much about your actual
business setup. Maybe you just set up a PayPal account, added some “buy now” buttons to your website, and started selling little doodads you made as a hobby. But then, before you knew it, you were thinking about quitting your job, and suddenly, filing taxes popped into your mind.
You’re not alone. Many new entrepreneurs already have a full-blown business long before they think about how to legally structure their business. But that’s a mistake and it can wreak havoc with your tax bill. So let’s take a moment and talk about your options before it gets to that point.
In most states you have three choices when it comes to business entities:
If you’ve stumbled into business, you’re probably set up as a sole proprietor right now. When your business is structured this way, you are your business. There is no separation of funds, either for tax purposes or if there is a lawsuit. You file your taxes just as you always have, with the addition of a Schedule C that records your business profits and losses.
Limited Liability Company
While still very similar to a sole proprietorship, the limited liability company (or LLC) offers some protection from debts incurred by the business. You still file your income tax return as if you and your business are the same, however, because to the IRS you are. LLCs are regulated by the state, and are not recognized by the federal government.
When your business is structured as either a sole proprietor or an LLC, you’re responsible for paying all the taxes, including the percentage of Social Security tax your employer used to pay when you worked for someone else.
If you incorporate your business, your business becomes completely separated from you as an individual. In fact, legally and for tax purposes, you’re actually an employee.
Corporations don’t file income tax returns, and you won’t receive 1099 forms from your customers. However, you will have to pay yourself a salary, which means sending withholding tax to the IRS for the money you earn.
In some cases, this can save you money because now the corporation is responsible for half your social security tax. But the added burden of dealing with payroll and more government paperwork means it might not be worth it to you, especially if you are running your business by yourself.
The best advice? When your business makes that transition from a hobby to a real business, it’s time to talk to an attorney, tax professional or qualified accountant. They’re the ones in the best position to discuss which business entity makes the most sense for you, your financial situation, and your business goals.
Photo credit: Mike Darnell