Do I need to be a LLC?
This is a common question for entrepreneurs and there is a lot of confusion between legal protection and IRS structures. First, let’s distinguish between the legal and IRS (tax) terms*:
Legal terms
What is a LLC? A LLC is a limited liability company and limits the personal liability of the business owner. If your business were to get sued or if your business went bankrupt, your personal assets could not be claimed.
Should my business be a LLC? Not necessarily. If you have less than $10,000 in personal assets (home, real estate, cash, investments) and if you are not likely to get sued (do not have employees, do not operate in the legal, financial, or consulting industry, do not have company vehicles or a brick and mortar), then you may not need to be a LLC. For example, I do not see very many creative entrepreneurs who sell product goods out of their home become LLCs.
Other protection to consider: If you do not become a LLC, you can still receive protection from professional insurance. There are two types of professional insurance:
General liability - provides coverage when someone outside your business files a claim against you for injury or damage. You should consider this if you have a brick and mortar, company vehicles, or perform work at another location.
Errors & Omissions - provides coverage when someone outside your business files a claim against you for malpractice or mistakes. If you operate in the legal, medical, real estate, consulting, advertising, or financial industry, you may want to consider E&O insurance. This will protect you even if someone falsely accuses you of negligence, contract breach, or errors.
In some cases, you might need both forms of insurance. You can learn more and get a quick quote from Hiscox.
IRS business structures
Often times, a business owner will tell me they are filing their taxes as an LLC. What they may not realize is the IRS will still classify their business as one of the following: (Note, everything herein is within the context of the United States Internal Revenue Service.)
Sole Proprietorship - one person is the owner of the business.
General Partnership - two or more people own a business.
Limited Partnership - two types of owners: general partners (who operate the business, make decisions, and have personal liability), and limited partners (investors who do not have the right to operate the business or make decisions and are not personally liable for business debts).
Corporation - a corporation is owned by investors (shareholders), who provide the funds, assets, or services used to operate the business. In a corporation, the shareholders elect a board of directors who are responsible for major business decisions. There are 2 types of corporations:
C corporations - corporate income tax is paid first at the corporate level and again at the individual level on dividends.
S corporations - have less than 100 shareholders and do not pay income tax at the corporate level. The profits/losses of the business are passed through to the business.
Should I convert to a S corporation? Not unless you have employees (are paying their social security and medicare taxes) and/or have net income of at least $50,000 annually. If you have employees, you may be able to save on payroll taxes if you file as a corporation. If you would like further clarification on whether you should classify your workers as employees or independent contractors, grab a free guide here.
Filing Taxes
Self-employed - If you are a sole proprietorship or an independent contractor, you will file your taxes as self-employed. You will pay income tax, just like someone who is employed by another business would. The standard tax rate for self-employment is 15.3% (as of 2020). The amount you pay will depend on your tax bracket and whether you are filing jointly. If you earned at least $400 in sales revenue during the year, you have to file income tax. You will also need to pay for your own medicare and social security taxes. You may need to file quarterly tax estimates. You can find out more on the IRS’ website.
Corporation - If you are a corporation, you will need to pay income tax and employment taxes (social security, medicare, unemployment, etc.). The federal corporate tax rate (for a C corporation) was 21% as of 2020.
Key Points to remember
You may not need a LLC. You could also consider professional insurance.
Make sure you file your taxes and file the right form (under the right business structure).
Do not convert to an S corporation right away. Make sure you consult with your CPA (certified public accountant) and lawyer when deciding which protection and business structure is right for you.
For a more detailed explanation of these points, watch the video below.
*Janey Stahl is not a CPA or a lawyer. Janey provides the information on this page as a public service for informational purposes only. Information contained herein is not intended to be, and should not be taken as, legal or financial advice. Users should consult with their CPA and lawyer.