Tax savings for the self-employed
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Eric Rosenberg is a finance, travel, and technology writer in Ventura, California. He is a former bank manager and corporate finance and accounting professional who left his day job in 2016 to take his online side hustle full-time. Eric’s writing has appeared in publications including the Huffington Post, Business Insider, Investopedia, and many others.
When you start a new side hustle or full-time business venture, you’re automatically considered a sole proprietor. As a sole proprietor, you effectively are the business. Working as a sole proprietor is easy and inexpensive, but as your business grows, it leaves you exposed to extra taxes and legal liabilities that you can avoid.
What’s my secret weapon against extra taxes and legal liability? An S Corp. S Corps are a different type of legal structure that many new business owners are less familiar with. However, they offer benefits over sole proprietorships and LLCs that can save you a small fortune every year.
Read on to learn more about why S Corps are such a great choice for small businesses, even when you’re the only employee, and how I use them in my own work as an online business owner.
My history with S Corps
I’m new here at the Collective blog (thanks for having me!), so here’s a little on my S Corp background. My online business started as a side hustle, and I set it up as a sole proprietorship. The business grew over time, and I upgraded to an LLC. This made sense for about eight years because it was a part-time business that didn’t earn me a huge income.
In 2016, I decided the time was right to leave my old day job and pursue full-time self-employment. The same month, I registered my business as an S Corp for the tax savings and flexibility. Starting on that day, I was no longer just an owner of my business: I became an employee-owner.
That employment status is an important distinction and key to saving thousands of dollars per year on taxes. Here’s a breakdown of the main benefits and why I love S Corps for any freelancer or entrepreneur who works for themselves full-time.
Why S Corps are perfect for small businesses
Before I set up an S Corp, all the income my business earned showed up on my personal tax return on Schedule C. I paid taxes on business profits, including the dreaded self-employment tax.
If you have a job working for someone else, your employer must match your payroll taxes when submitting them to the government. When you own a business, you have to pay the employer’s portion of the taxes yourself.
But when you work as an employee of your very own S Corp, not all of your business’s earnings have to be subjected to self-employment tax. As long as you pay yourself a “reasonable” salary (in the eyes of the IRS) through payroll, you only pay self-employment taxes (which are now called payroll taxes) on your employee wages.
Any income above your salary isn’t subject to payroll taxes, just your regular income tax rate. So even if you have to pay for a payroll service, you’re still probably coming out ahead, depending on your total business income and salary.
Both LLCs and S Corps offer legal protections you don’t get as a sole proprietor. This could make it worth creating a business entity for your side hustle, even if it’s very small. Every state has different taxes and fees to create a business, so your decision on when to incorporate will likely depend on where you call home.
I lived in Colorado early in my online business career, where creating an LLC or S Corp is fairly cheap. Once I had that set up, my personal assets, including my home and savings, wouldn’t be included in any kind of settlement if I were in a legal dispute.
To make this work, it’s important to maintain a “corporate veil” — that’s a strong division between your business and personal finances — and follow other rules. But if you still end up on the wrong side of a lawsuit, you shouldn’t have to worry about losing your house in the suit.
When I hire a professional to do any kind of service, I’m slightly taken aback if they accept payment under their own name. A business registration tells me they are serious about what they’re doing and have gone through extra steps to run their business like a business.
If I’m billing a client, they don’t get an invoice asking for a check to Eric Rosenberg. They get an invoice from my S Corp with several payment options. Checks are written to my business, which is an important part of maintaining the corporate veil. It also tells other businesses that I’m serious about what I do.
If you want to be perceived as a professional, then registering an S Corp is a big step in the right direction.
When someone chooses between you and a competitor, a more professional appearance could be the deciding factor. That might lead to more dollars in your bank account.
Ready for the future
The COVID-19 pandemic was a stark reminder of how quickly business can change. Many businesses saw thriving sales drop to zero overnight. Others saw demand rapidly rise if they catered to delivery, online shipping, or anything related to face masks and hand sanitizer.
If you decide to raise funds to grow, you can add new owners to an S Corp in a much simpler way than with a sole proprietorship or some partnerships.
You may plan on running your business forever, but if you decide to sell it someday, then selling a corporation is also easier. There’s a lot more flexibility when it comes to managing your business capital with a corporation.
Too many small businesses are missing out
Before the virus locked many of us at home for months on end, I went to a wide range of conferences for entrepreneurs and hustlers who were growing their construction companies, travel blogs, financial brands, and other types of businesses.
I was shocked by how many people worked as sole proprietors simply because it’s the path of least resistance. Many “experts” didn’t realize they were overpaying on taxes or leaving themselves vulnerable to lawsuits, even at financial conferences.
I would be paying around $12,000 more per year if it were not for my S Corp. That’s enough savings to retire years earlier or send my kids to college!
Don’t be one of those people missing out. Once your business earns enough to pay yourself a full-time salary, you’re in a perfect position to convert to an S Corp. If saving money and additional legal protections sound like a good thing to you, check out Collective’s tax-savings calculator to find out how much you can save with an S Corp.
Eric Rosenberg is a finance, travel, and technology writer in Ventura, California. He is a former bank manager and corporate finance and accounting professional who left his day job in 2016 to take his online side hustle full-time. You can connect with him at Personal Profitability or EricRosenberg.com.