Today's guest post comes from June Walker, tax and financial consultant to independent professionals since 1979 and, luckily for us, one of our speakers for the upcoming Creative Freelancer Conference this August in San Diego.
Every business conducts its affairs as a particular kind of business entity (or business structure). The organizational form that you choose determines which tax and legal regulations will apply.
For tax purposes the IRS gives a choice of the following kinds of business structures:
· Sole proprietorship
· Partnership (several types)
· Corporation (two types)
If you’re a self-employed in business and you have done nothing about a business entity, your business is already structured. It is a sole proprietorship.
There is no need to complicate where simplicity will suffice. For all but a few newly-hatched solo ventures a sole proprietorship is the way to go.
Wait. Wait. Wait.
If cousin Harry at the schvitz or Aunt Tillie during Thanksgiving dinner told you that you’re a big boy now and you’d better incorporate, hold on a minute. Don’t rush into anything. Get some information.
When you look at how to structure your indie business, trying to decide which entity is best for you, be sure to ask yourself the right question. (I know I’m always advising on how to ask a smart question. Well, you must, if you want a smart answer, that is.)
So, ignoring Harry and Tillie for the moment, are you looking to change your business entity for tax reasons or for liability purposes?
If it’s for tax reasons, as a sole proprietor are you taking full advantage of every tax law and reg available to you? Don’t go into the expense and hassle of incorporation if you can’t answer a firm yes to that question.
The Feds say that nearly four out of five businesses in the United States are sole proprietorships. Yet just about every lawyer advises a budding indie to incorporate. In twenty-five years of experience I have found only one attorney who didn't answer “yes” when asked “should I incorporate?” And every new client that has come to me already set up as a corporation said he or she did it because “my attorney (or my accountant) told me to do it.” None of them had a clear idea of why incorporation was supposed to be an advantage.
The tax benefits of incorporation are pushed heavily by attorneys because that’s what they’re used to: working with corporations, not working with solos who design websites or computer programs. They don’t know the tax benefits available to indies!
Sometimes there are good reasons why a self-employed should incorporate, but, if advised that you must do it, find out why. Be sure the professional explains to your satisfaction – and also to the satisfaction of a savvy friend, colleague or relative -- what makes incorporation necessary.
Facts -- to stifle some old husbands’ tales:
All business structures
· allow you to deduct business expenses
· allow some sort of deduction for medical insurance
· allow for contributions to pension plans
· allow you to hire employees or subcontractors
· allow the other guy to sue you
· do not allow you to hide income
· do not allow you to write off personal non-business expenses
To read more continue here…
Attend June’s seminar, Tax Solutions for Creatives, at CFC in August. Want to have June address your specific question? Email her at june@junewalkeronline.com and please note CFC in the subject.
June, I wish I had read this post prior to forming my S-Corp. for my freelance writing business. Our accountant had encouraged me to do so saying our taxes for 2008 could have been considerably less. My income right now is not considerable and therefore I thought I could get away with not having to incorporate for a bit longer.
Posted by: Alysia | June 23, 2009 at 11:15 AM
June, what are your thoughts on forming a single-member LLC? (As I understand it, essentially still a sole-proprietorship for tax purposes)
Thank you!
Posted by: Merry | July 07, 2009 at 03:48 PM
Hello Merry,
I recommend anyone interested in forming an LLC or just wanting to know more about what it is, read my posts on LLCs on my blog, here, http://junewalkeronline.blogspot.com/search/label/business%20entity%20--%20LLC.
An LLC is a legal entity, not a tax entity.
A sole proprietor may become an LLC and there will be no change in the tax treatment of his or her business. You form an LLC for legal reasons, for instance, asset protection; or for marketing and PR reasons, for instance, "LLC" after your name adds a little panache.
If you have similar reasons, then consider forming an LLC.
To maintain the veil of legal protection of an LLC there are strict recordkeeping rules. However, once again, the rules are for legal purposes not because of tax regulations.
In tax jargon, a sole proprietorship established as an LLC is called a "disregarded entity."
After you've checked out the LLC info on my blog, please email me if you have other questions.
June Walker
june@junewalkeronline.com
Posted by: June Walker | July 08, 2009 at 08:11 PM
Alysia,
You can always dissolve a corporation without a lot of hassle.
If an accountant recommends that you form an S-corp to pay less tax ... check him out. In many instances the way of saving on taxes is by treating earned self-employed income not as earned income but as profit and thereby fraudulently avoiding self-employment tax.
The IRS knows about this. The IRS needs money. The IRS is going after S-corps set up solely to avoid tax.
June Walker
Posted by: June Walker | July 08, 2009 at 08:18 PM