Whether you call yourself a freelancer, entrepreneur, self-employed contractor, or consultant it’s important to make sure you establish a legitimate business structure.
What makes starting an online business so attractive is how easy it seems to get started. After buying a domain, setting up a hosting account, and installing WordPress you’re in business. In reality, setting up a real business involves some legal effort that cannot be ignored.
Real businesses require a legal business structure for many reasons, including the protection of personal assets and income tax benefits – neither can be ignored when you go into business for yourself. Determining which business entity is right for you can be tricky.
Sole Proprietor is where many people start. Operating as a sole proprietor involves little more than simply stating “I’m in business.” With this structure, you and your business are one and the same. There is no legal separation of assets or liabilities; and no special tax forms to fill out. You may want to apply for an employer identification number just to help prevent identity theft; and your local government may require you to apply for a DBA (doing business as)..
While this is indeed where most online businesses begin, it is not the ideal place to stay. Operating as a sole proprietor offers no protection for your personal assets should you be sued for an issue related to your business. It means you are personally responsible for any business debt you accumulate. In addition, this structure may not be the most advantageous for your tax status, because all of your income is taxed as personal income.
Limited Liability Company, or LLC
A limited liability company is nearly as easy to set up as a sole proprietorship, but affords a degree of protection for your personal assets, similar to a corporation. As an LLC, you will file your income tax just as you would if you worked a “real job,” so you don’t have to worry about any complicated filing requirements. You do; however, have to be careful to clearly separate your business from your personal finances. Failing to do so can make you vulnerable should your company be sued.
In most states you can set up an LLC yourself for a small fee just by filing some paperwork with the office of the Secretary of State. You can save yourself a bit of time and trouble by having an attorney handle it for you. Many local attorneys will file all the paperwork for you at a very reasonable rate (around $500), and file for your federal tax ID (EIN) number at the same time.
Starting and running a corporation is a bit more complicated than an LLC, but it does have some additional benefits; such as, the ability to sell shares (or part ownership) in the company to raise funds. Corporations come in two ‘flavors’ – S-Corp and C-Corp – with the primary distinction being how they are taxed.
An S-Corp is taxed the same as an LLC, meaning all profits and losses are claimed on the owner’s personal tax returns. A C-Corp is taxed as an entity itself, and any income you pay yourself (as payroll) is also taxed on your personal return. Deciding which choice is right for you and your business can be tricky, so it’s a good idea to speak to an attorney or accountant.
Keep in mind that laws vary from state to state. Before deciding which business structure is right for you, it pays to do your research. Talk to other small business owners, read through the documentation at LegalZoom.com, and search your own state’s online documentation. Whatever you do, don’t neglect this decision; because operating as a real business is the first step to building your empire.
Do you have experience switching from one business structure to another? Or a compelling reason to choose one entity type over another?