At Independent Contractor Tax Advisors, we consult contractors on the various business structures available to them everyday. We often hear, “which business entity is the best for me?” The answer, like many issues involving taxes, is “it depends.” You essentially have four structures to chose from (Sole proprietor, LLC, C Corp, S Corp), and when making your choice, there are three things you need to consider: simplicity, legal protection, and taxes.
SOLE-PROPRIETORSHIP
Pros
Sole proprietors are common because they’re extremely easy to set up and maintain. It doesn’t cost you anything to set up and there is no separate filing, it only requires you to file a schedule C with your personal tax return.
Cons
100% of your income is subject to self employment AND income taxes. Not only that, sole proprietorship leaves you exposed legally. If someone were to sue you for liability, they could take you for everything you have.
LLC
Pros
An LLC is still simple to open and maintain as most states only require an annual LLC filing and fee to keep the LLC open, but the LLC does not file a separate tax return. It also establishes what is called the corporate veil, which separates your personal finances from your business entity. So if someone were to sue you for liability, the most you could lose is your company as long as all compliance standards were followed.
Cons
As a single-member LLC, you are taxed as a sole proprietor, so 100% of your income is subject to self employment and incometaxes. This can potentially cost you thousands in extra taxes.. Now, to open an LLC, you will have to pay an initial fee, and there might be an annual fee required by your state to keep it open as well.
(Should you form your LLC in Delaware? Click here to find out)
C CORPORATION
Pros
A C-Corp provides you legal protection by establishing the corporate veil. So if someone sues you for liability, you only stand to lose your business.
Cons
First, a C-corp is subject to double taxation, where the corporation pays taxes on all income and then you have to pay taxes on everything you withdraw from the corporation (also known as dividends). There is also a heavy compliance burden involved with a C corporation. There has to be a board of directors, which in most cases for small business owners consists solely of you, and you have to provide annual minutes of your meetings to the state. In addition to your personal return, you will need to file a separate business tax return at the end of the year.
S CORPORATION
Pros
An S corp allows you to shield a portion of your income from self employment taxes, by allotting you a salary in the form of W-2 income, and the remainder is received as tax efficient dividends or distributions. It also makes certain deductions more straight forward, like the home office, and travel. An S corp establishes the corporate veil, protecting you and your assets from liability suits. An added benefit is that in many states, if you need to, you can fire yourself and collect unemployment.
Cons
An S corp only becomes a viable option when your business is netting $30,000 dollars at a minimum, per year. Having an S corp requires you to process payroll, because you are an employee of the S corp, as well as the corporate officer. You can take care of payroll yourself or opt to hire a payroll service. At the end of the year, you will need to file a separate business tax return, in addition to your personal return.
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