By Thomas Arrison, Certified Public Accountant
Let’s get into the specifics
The first question is “How do I actually go into business for myself?”
It really can be very simple.
In essence you can start your business by standing in your living room and saying “I am in the business of writing blogs (or software support, or making furniture).” Of course, that is not going to put one dollar in your pocket. Which brings us to the next question “What do I do now?”
The real question should be “What form should my business take?”
Lets eliminate corporations right away. No matter what your friends or family say, incorporating your business at the beginning is probably not the right way to go. It requires filing long and formal documents with the Secretary of State and the spending of a lot of money on filing fees, legal fees, accounting fees, insurance, etc. just to set up the corporation. Then you have to pay $3,000 annually to keep the corporation alive. The major benefit of a corporation is to limit your liability, and there are alternatives to using this structure.
Now let’s talk about a Limited Liability Company (LLC).
Like a corporation, you are required to register your LLC with the Secretary of State and pay a filing fee. The fees vary by state. The registration process is easy and generally just a one page form. Then you have to keep the LLC alive by filing an annual report each year. There is of course another filing fee for the annual report.
There are benefits to an LLC. First, it does limit any liability that could arise within the business from affecting your personal assets. For example, you decide to paint houses while you are looking for your dream job as a CEO. The first house you paint catches fire and burns to the ground. An LLC will hopefully protect you from losing your house and other assets.
To accomplish this you must observe all the niceties of having a business. You will need a separate business checking account in the business name. You should always use business stationery in the company and sign as Managing Member, not just your name. Everything you do for business should be in the LLCs name.
There is more good news about the LLC. If you are the only member you do not need to file a separate tax return for the LLC. The income and expenses of the business go on Schedule C of your personal 1040 tax return. It is also less expensive to run because you are not paying a tax preparer to prepare an LLC return and your personal return.
The other reason to have an LLC is that it makes you appear bigger than you are and you can get jobs with large companies that would not deal with you as a sole proprietor. The IRS has gone after many large companies for classifying individuals as contractors instead of employees. The IRS collects more in taxes that way. So many big companies have set a hard and fast rule that they will not use sole proprietors as contract persons.
Finally there is the sole proprietorship.
Essentially when you stand in the middle of your living room and declare yourself a business you have become a sole proprietor. The niceties of the LLC or corporation do not have to be observed. You can run the business through your personal checking account. You do not have to register with the Secretary of State. You do your work, collect your invoices (hopefully), pay your bills and keep the rest of the money. At the end of the year, your business activity is reported on Schedule C of your 1040 Form.
The plus side… It is simple to start and close a sole proprietorship. You end it by standing in the middle of your living room and saying, “I’m out of business!” Your record keeping requirements are much simpler. (Record keeping will be explained later.) The cost to stay in business is much lower than a corporation or LLC.
The downside… If something goes wrong, all your personal assets are on the line. They can take your house and all your assets. A homestead exemption will help protect your home. Under federal law, retirement assets are generally not available to creditors.
More bad news… Most large companies will not deal with you as a sole proprietor.
My recommendations:
- Do not incorporate.
- Establish an LLC if you are concerned about liability or companies you might work for require it.
- Form a sole proprietorship if it fits your situation
About Thomas Arrison
Thomas has been a CPA for over 30 years. Since 1992 he has provided individual and business tax and accounting services at Arrison & Olden, PC in Littleton, MA. He also has his own blog, Thom’s Tax Talk, a compendium of tax tidbits and information.
