Chances are, when you started out working online, you didn’t put much thought into your actual business setup. You probably just set up a PayPal account, added some “buy” buttons to your website, or maybe created an invoice or two for clients. Before you knew it, though, you were thinking about quitting your job, and suddenly, filing taxes was a huge concern.
The truth is, many new entrepreneurs are well on their way to having a full-blown business long before they put any thought at all into legal business structures, and that can really mess with your tax bill. In most states (and we’re speaking of the US, here) you have three choices when it comes to business entities:
Sole proprietor. This is where you started when you sent your very first Pay Pal invoice. When your business is structured this way, you are your business, and your business is you. There is no separation of funds, either for tax paying purposes or in the event of a law suit. You file your taxes just as you always have, but you’ll also need to add a Schedule C to record your business profits and losses.
Limited Liability Company. A small step up from a sole proprietor, the limited liability company (or LLC) affords you some degree of protection from debts incurred by your business. However, you still file your income tax return as if you and your business are the same – because as far as the IRS is concerned, you are. LLCs are regulated by the state, and not recognized by the federal government.
When you operate as either a sole proprietor or an LLC, you are responsible for paying the entire amount of your taxes. That means that the percentage of Social Security tax your employer used to pay is now your responsibility.
Corporation. When you incorporate your business, you are saying that your business is completely separate from you as an individual. So separate, in fact, that you’re actually an employee.
The good news is, corporations don’t file income tax returns, and you won’t receive 1099 forms from your customers. The bad news is, you will be required to pay yourself a salary. That means that every month, you (the corporation) will be required to send withholding tax to the IRS.
This can mean savings for the entrepreneur, because now the corporation has to foot the bill for half your social security tax. But the added burden of dealing with payroll and even more government paperwork means it might not be worth it to you.
The best advice? When your business turns from a hobby – meaning you’re earning more than pocket money – into a real business, it’s time to talk to an attorney or qualified accountant. They’re the ones who can best advise you about the business entity that makes the most sense for you, your financial situation, and your business goals.
