Freelancer? Independent contractor? Side hustler? Whether you’re an established business-of-one, or just starting out on your journey as a solopreneur, one thing you should have clear is how to organize your business. It’s time to think about what type of business entity you should have.
Are you tempted to avoid the question altogether? Maybe you’ll just cruise along in the sole proprietorship default lane?
Don’t do that. This is actually a really important decision, one that will make a huge difference in the way you run your business, your ability to protect your personal assets and–listen up!–your ability to pay fewer taxes. Potentially thousands of dollars less. Year after year.
We thought so. Saving money has a way of grabbing our attention, right?
Let’s find out which business entity is right for you. We’ll do our best to simplify as we lay out the pros and cons of each–the advantages, disadvantages and key factors to help determine which business entity makes the most sense for your business.
Before we can compare different entities, let’s clarify exactly what a “business entity” is. Put simply, a business entity is an organization created to conduct business. (Easy, right?) And the most common business entities for businesses-of-one are:
This is how your business will operate if you simply start working. A sole proprietorship is:
With a sole proprietorship, all the business’ assets, debts, income and liabilities rest with you. And your business profits are reported on your personal tax return. It’s quite straightforward and, depending on your business, could work out just fine–which is probably why over 75% of solopreneurs start out as sole proprietors.
That lack of separation of personal and business accounting is one of the major motivations to opt for an LLC. For business owners who want to keep their personal finances and legal liabilities separate from their business, the Limited Liability Company (LLC) does just that. An LLC:
Let’s see if we can help answer that question.
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Sole Proprietorship |
LLC |
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| Costs | ||
| + | No government fees | |
| – | Possible local business license fees | Filing fee, local business license fee, annual taxes, tax preparation fees |
| Formation | ||
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No formal set-up or business formation required of you
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You have a one-time setup
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| – |
You must file Articles of Organization; get business license; written Operating Agreement recommended
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Liability
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+
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Gives you personal liability protection
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–
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There is no liability protection for your business debts or legal claims against you
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You can still be liable for personal negligence or malpractice
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Tax Filing
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+
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You file as part of your personal return
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Your business files taxes as its own legal entity
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–
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This co-mingles your personal and business finances
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Requires completion of a separate tax return, a K-1 form
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Tax Saving
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+
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Your business losses may offset personal losses
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You can choose to be taxed as a corporation or not
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–
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You pay the full 15.3% self-employment tax
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You pay the full 15.3% self-employment tax
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You don’t start to see tax benefits until you choose to be taxed as a corporation, which we’ll talk about next.
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If you decide to go with an LLC, you also have the option to file your taxes as a corporation. While you’d retain your LLC as your official business entity, a C or S Corp designation would change some ways your business is run and, most importantly, the way the IRS taxes your LLC.
In addition, you may have heard that becoming a corporation allows you to attract outside investors, offer stock options to employees, or conduct a public stock offering. As a solopreneur, you’re probably thinking, “Oh, that’s not for me.” But here’s the thing, those particular benefits may not be relevant to your business, but there are others that are–and they should not be dismissed lightly!
With a C-corp, you can file a separate business tax return and pay income tax of 21% on net business income, which may be less than you’d pay as an individual. This comparatively low rate is especially beneficial to high-earning businesses, as your tax rate doesn’t rise with your net income.
However, if you expect to show a loss at any time, perhaps when you’re just starting out, C-corp status will not allow you to deduct those losses from your other (e.g. personal) income.
With an S Corp, you’re looking at the most popular filing status amongst businesses of one. Why? For the simple reason that S Corp status can lower the amount of self-employment tax (Social Security and Medicare) you pay. As an LLC alone, you’re stuck paying the full 15.3% (vs. paying half of that as a W2 employee of a company). This savings, alone, could add up to more than any incorporation (and LLC) costs. It’s all about keeping more of what you earn, right?
No matter which Corporation status you might choose, it’s also important to keep in mind a few more key facts:
We’ve shared a lot of information. Hopefully, you feel empowered to make a more informed decision about your business entity. If so, awesome. But if you’re being honest and find yourself now more confused than ever, you’re not alone. Not only do many fellow business-of-one owners feel the same way, but all of you have something else in common: Lettuce.
We are an cutting-edge finance and accounting system designed to hold your hand (virtually, of course) through every step of the decision-making process–from setting up to managing all of the compliance of your LLC and S Corp. We even do your business taxes. We do the work of making sure you follow the tediously complex rules and regulations, so you can see all of the savings. We’re here to provide the up-to-the minute insights and money-saving advice. Lettuce can make setting up your business a breeze and make sure you pay only the taxes you legally owe.
Find out fast, free, and with zero obligation using our ingenious (if we do say so, ourselves) S Corp tax calculator. (Hint: It’s probably in the thousands.)