You have made the decision to become self-employed, either full time or part time. You are excited and know your business will grow, and maybe you will even hire others to work with you. But then you say, now what?
The first thing you need to decide is whether you want to operate as a sole proprietor, a partnership, a limited liability corporation, an S corporation or a C corporation. Each of these business entities has its pros and cons.
Sole proprietor
According to the U.S. Internal Revenue Service, a sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.
When you file your taxes in the U.S. you will file your earnings and expenses on your tax form 1040 and Schedule C of the 1040, Profit & Loss from a business, or Schedule C-EZ, Form 1040, Net Profit from Business. You may also have to file a Schedule SE, Form 1040, for self-employment tax; Form 1040-ES, estimated tax for individuals. Social Security and Medicare taxes and income tax withholding are filed on forms 941 and 944. You may have to create a W2 for yourself and employees, and a Form W3 is sent to the Social Security Administration. The 940 Federal Unemployment Tax form (FUTA) also is filed with the IRS. If you have contractors, you will need to send a 1099 form and file their information with the IRS, as well.
Partnership
A partnership is the relationship between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill and expects to share in the profits and losses of the business.
A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it “passes through” any profits or losses to its partners. Each partner includes his or her share of the partnership’s income or loss on his or her tax return.
Partners are not employees and should not be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including extensions.
When you file your taxes, you may be required to file a 1065, U.S. Return of Partnership Income, employment taxes and forms as previously stated.
Individually, you will file your 1040 and Schedule E, Supplemental Income and Loss; Schedule SE, Self-Employment Tax; and 1040-ES, Estimated Taxes.
LLCs, S Corps and C Corps
A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state may use different regulations, and you should check with your state if you are interested in starting an LLC.
Owners of LLCs are called members. Most states do not restrict ownership, and so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner.
S corporations are corporations that elect to pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
To qualify for S corporation status, the corporation must meet the following requirements:
- Be a domestic corporation.
- Have only allowable shareholders that
- May be individuals, certain trusts and estates.
- May not be partnerships, corporations or non-resident-alien shareholders.
- Have no more than 100 shareholders.
- Have only one class of stock.
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies and domestic international sales corporations).
You may have to file an 1120S, 1120S Sch. K-1, 1120W and 8109, Estimated Taxes; plus employment tax forms. Personally, you may have to file 1040 and Schedule E and other possible forms, including a 1040-ES, Estimated Tax.
In forming a corporation, prospective shareholders exchange money, property or both for the corporation’s capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.
The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.
You may need to file an 1120, US Corporation Income Tax form; 1120-W, Estimated Tax Form; and employment tax forms
Deciding on the type of business entity you will be is very important, since the classification affects how your taxes are handled. The best suggestion is to discuss your business plans with an attorney and a certified public accountant. The upfront expense is worth it, as making the wrong decision can be expensive.
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Princess Accountaholic is an accountant who works with adult-industry clients. She’s an expert about the laws and regulations governing the industry’s taxes and where legitimate tax savings may exist. Contact her at virtualfinancexxx@gmail.com.
