Should I Become a Business?

“I’m doing X as a 1099 side job or Y freelance work, should I become a business?” The answer is that you already are a business. The real question is what formal steps you should take to save taxes and avoid liability.

You’re Already a Sole Proprietorship

If you’re earning 1099-MISC income, are selling items, or are performing services as a non-employee, you are already a sole proprietorship. Just to be clear, a sole proprietorship is a business.

Most businesses are sole proprietorships because they’re easy to form. As you can see, you may not even know you formed one.

From a tax standpoint, sole proprietorship income is added to your personal tax return and taxed at your personal tax rates. You’ll likely need to file a Schedule C or Schedule C-EZ along with your 1040. You’ll be able to deduct your ordinary and necessary business expenses, and may be eligible for the 20% pass-through deduction.

To get a better idea of your potential taxes, you can use these tax calculators.

There are also a few legal questions you probably want to ask a lawyer.

  • Do I need to register with my state or local government?
  • Should I register a fictitious name or DBA if I’m doing business as a name other than my given personal name?
  • Do I need a permit, license, or tax receipt from the state, county, city, or other jurisdiction?
  • Is there anything else I need to know from a legal standpoint?

Other Business Types

If you’re already a sole proprietorship, the real question you might be asking is should I use another business entity type.

  • Partnerships are like sole proprietorships in that you may already have one without knowing it if you’ve been working with one or more partners. There are also special types of partnerships, such as Limited Liability Partnerships, and having a formal partnership agreement to spell out exactly how you’re going to work together and share profits and losses is always a good idea.
  • Corporations provide a large degree of protection for your personal assets against lawsuits, debts, and other claims against your business. You’ll need to ask a lawyer for specifics on what legal protections you’ll receive. It depends on your state and the type of business you’re doing.
  • C-corporations are corporations that are taxed at a flat 21% tax rate. If you pay yourself a salary, you’ll give yourself a W-2 and pay personal income taxes on it (but the corporation can deduct the wages for its own income taxes). If you take out dividends, you’ll pay your dividend tax rate on them.
  • S-corporations are a special type of corporation where corporate profits and losses pass through to your personal tax return. There is no corporate tax, but you pay your personal income tax rate on your share of earnings.
  • Limited liability corporations give similar liability and legal protections to corporations but have different rules and filing requirements. You may choose between having your LLC taxed as a sole proprietorship/partnership, a C-corporation, or an S-corporation.

So What Business Type Should You Choose?

Now that you know you’re already a business and are really trying to figure out if you should change your business entity type, which should you choose? The answer is that there’s no easy answer, because it depends on what you’re selling, your long-term goals, and your overall tax picture. Ask both a lawyer and an accountant to learn more.

To learn more, check out this guide to forming a corporation or LLC.

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