Tax Strategy for Self-Employment Income, Part 7: Forms of Doing Business
As we have seen in previous episodes of this series, selecting the right retirement plans for different self-employment scenarios can bring substantial tax advantage by deferring large amount of income. Now let's discuss the other aspect of our tax strategy: forms of doing business. Unless a business is formed, the status of self-employed is usually "sole proprietorship." But as we can see soon, people in self-employment status can also choose to form business entities for legal and tax benefits.
In this series, we will take a look at three basic forms of doing business that may appeal to the self-employed: Limited Liability Company (LLC), S Corporation and C Corporation.
Without getting to the details of each form, let's apply our framework and briefly discuss how a business entity can improve the tax situation for self-employed:
• Tax Deduction: While most business expenses can be deducted as a sole proprietor, business entity can deduct slightly more items, especially in the employee benefits area.
• Income Deferral: All the retirement plans for the self-employed we just discussed are still available when a business entity is formed.
• Transfer of Income: Having a business entity will make transfer of income between spouses much easier. The business will take all income, and redistribute it to both spouses as salaries, while you, instead of your customers, decide who gets how much (to some extent).
• Shift of Income Timing: In the case of C corporations, having a business can move your income from one calendar year to the next, because the tax year of a business does not have to be the same as your personal tax year (which is usually the calendar year).
Furthermore, having a business entity brings more benefits other than tax. Most importantly, the business entity shields your personal liability, so in the unlikely event that someone sues you for damages that are caused by your service, your personal assets will still be safe. Plus, having a business entity brings credibility to your business, and make it easier for you to attract large customers.
Let's start by discussing LLC and S Corporation.
This post is part of the Tax Strategy for Self-Employment Income Series, please also read the rest of the series:
Part 1: The Tax Exposure
Part 2: The Framework
Part 3: The Major Options
Part 4: Individual 401(k) Introduction
Part 5: Individual 401(k) Analysis & Resources
Part 6: SEP IRA and SIMPLE Plans
Part 7: Forms of Doing Business
Part 8: LLC and S Corporation
Part 9: C Corporation
Part 10: The Conclusion
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"the business entity shields your personal liability, so in the unlikely event that someone sues you for damages that are caused by your service, your personal assets will still be safe."
Not necessarily true. There is something called "piercing the corporate veil."
Unless you have a good grasp of the legal, tax, and accounting issues, you may want to stay away from giving such advice.
I think most people should start with a sole proprietorship since most people don't even make any money to being with. Corporations require more paperwork and more taxes.
