Self-Employed Individuals

Self-employed individuals who work in the building trades, as consultants, instructors or real estate professionals, are usually compensated for their work as contractors rather than as employees. This means that no Federal income, Social Security or Medicare taxes, or State income taxes, are withheld from their compensation.

Each business or individual for whom you work should ask you to provide a completed Form W-9. You can obtain a blank Form W-9 here: https://www.irs.gov/pub/irs-pdf/fw9.pdf. Once you’ve filled in and signed your Form W-9, you can provide a copy of the same completed Form W-9 to each business or individual for whom you work.

Types of Business Entities

You can create your new business based upon any of several types of business entities. These range from very simple to more complicated. Like most things in this life, there is no “right” business entity for a small business owner, only a range of viable alternatives to choose between.

Marketing Tip

If you envision that your business will have some level of online presence, you should first visit www.GoDaddy.com to review what web site addresses – more commonly referred to as “URLs” - might still be available for you to use. You can purchase the right to reserve and exclusively use a particular URL from GoDaddy.com.

These are the simplest of business entities which do not require any legal advice or registration with the State to establish:

  1. Sole Proprietor. The simplest of all business entities that you can choose. You do business under your name. No new legal entity to establish and manage.
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    Income and expenses are reported on your Federal Form 1040 tax return, Schedule C.
  2. Doing Business As … (“d/b/a”). Identical to a “Sole Proprietor” except that you have created a new name for your business. Generally, you can choose whatever name you’d like for your business. Keep in mind that you should avoid using any names that are similar to those of other businesses, especially potential competitors, in your local area.

As with the “Sole Proprietor”, income and expenses are reported on your Federal Form 1040 tax return, Schedule C.

These more complex business entities may require some legal advice and will require registration with the State to establish:

  1. Limited Liability Company (“LLC”). A Limited Liability Company (LLC) is a business entity created by State statute. Its owners are called “members”. Please note that “LLC” is NOT an acronym for “Limited Liability Corporation”.
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    Depending on elections made by the LLC and the number of its members, the IRS will treat an LLC either as a corporation, partnership, or as part of the owner's tax return (a "disregarded entity").
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    An LLC with only one member is treated as “an entity disregarded as separate from its owner” for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation. A single-menber LLC is a “pass-through” business entity. Income and expenses are reported on your Federal Form 1040 tax return, Schedule C. You can learn more about single-member LLCs here:  https://www.irs.gov/businesses/small-businesses-self-employed/single-member-limited-liability-companies
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    An LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and elects to be treated as a corporation. A multiple-menber LLC is a “pass-through” business entity. Income and expenses are reported on your Federal Form 1065, Form 1120-S or Form 1120, as discussed in more detail below. These business income tax returns require the reporting of Balance Sheet and Equity amounts in addition to income and expenses.

Tax Tip

Most married couples who file jointly usually title all their real property jointly in a 50%/50% ownership arrangement. Couples who are considering the establishment of an LLC business should carefully consider which version of LLC to establish.

In a “single-member” LLC, only one spouse is listed as the “member”. Income and expenses are reported on your Federal Form 1040 tax return, Schedule C.

In a “multiple-member” LLC, both spouses are listed as “members”. Income and expenses are reported on your Federal Form 1065, Form 1120-S or Form 1120. The costs to prepare such business tax returns can run from $500 to $1,000 or more per year, without providing any additional tax benefits to either spouse.

  1. Partnership. A “Partnership” is exactly that – a group of like-minded individuals, or in some cases business entities, who band together to form a business entity. Partnerships are popular with professional business associations, such as architectural firms, consultants, CPA practices, law firms and medical practices, and with natural resources and energy businesses such as oil and natural gas exploration and production companies. Partnerships also provide a good mechanism for the senior members to transfer their ownership interest to junior members as they near retirement age.
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    A Partnership is a “pass-through” business entity. Income and expenses, assets, liabilities, and equity are first reported on the partnership’s Federal Form 1065 tax return. Each Form 1065 return includes a Schedule K-1 for each partner that reports the amounts of income and expenses, assets, liabilities, and equity in proportion to each partner’s ownership percentage. These amounts flow through to the partner’s Form 1040 tax return, Schedule E, p.2.
  2. S-Corporation (“S-Corp.”). An “S-Corp.” is one type of legal business structure common among small businesses. S-Corp.’s get their name from Subchapter S of the Internal Revenue Code (IRC), under which they’ve elected to be taxed. Requirements of an S-Corp. give a corporation with 100 or fewer shareholders the benefits of incorporation while being taxed as a partnership. One of the most compelling reasons to form an S-Corp. is to avoid the double-taxation levied on C-Corp. income.
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    An S-Corp. is a “pass-through” business entity. Income and expenses, assets, liabilities, and equity are first reported on the S-Corp.’s Federal Form 1120-S tax return. Each Form 1120-S return includes a Schedule K-1 for each shareholder that reports the amounts of income and expenses, assets, liabilities, and equity in proportion to each shareholder’s ownership percentage. These amounts flow through to the shareholder’s Form 1040 tax return, Schedule E, p.2.
  3. C-Corporation (“C-Corp.”). The “C-Corp.” is the granddaddy of all business entities in the United States. C-Corp.’s get their name from Subchapter C of the Internal Revenue Code (IRC), under which they’ve elected to be taxed. C-Corp.’s are independent legal entities, owned by their shareholders, that have unlimited growth potential. Most large businesses and public companies are formed as C-Corp.’s because a C-Corp. is a business structure that allows for limitless growth through stock sales (which makes them appealing to investors) and is ideal for large, retail-based businesses.
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    A C-Corp. is not a “pass-through” business entity. The C-Corp. itself is first taxed at the federal corporate tax rate of 21%. Any dividends or profits the company passes on to its shareholders are taxed a second time as personal income.
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    Don’t be blinded like a deer in the headlights over the Tax Cuts and Jobs Act of 2017 (TCJA) provisions that lowered the nominal Federal corporate income tax rate from 35% to 21%. For most small business owners, these provisions are rather meaningless.
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    Because a C-Corp. does not by definition include any “pass-through” mechanism, another drawback to C-Corp.’s is that cash can be distributed out of a C-Corp. only via salary and wages, or via cash dividends, both of which are taxable income at the personal level. This drawback makes a C-Corp. a less desirable choice for the small business owner.
  4. Other Business Entities. There are several other, more specialized business entities, such as PLCC’s and PC’s, that one could consider. These entities are established less frequently by small business owners than those described above. For that reason, I have opted not to discuss them here.

You can learn more about business entities here: https://www.irs.gov/pub/irs-pdf/p5868.pdf

Obtain a Federal Employer Identification Number (EIN)

Obtaining a Federal EIN is a great way to create some separation between your personal identity and that of your new business. With an EIN, you won’t have to provide your SSN to customers or vendors.

You will need an EIN to open a bank, credit card and/or investment account in your business’s name.

Applying for an EIN is a free service offered by the Internal Revenue Service. Beware of websites on the Internet that charge for this free service.

You can apply for an EIN online, by mail, FAX or telephone. Applying online is the preferred method. Once the application is completed, the information is validated during the online session, and an EIN is issued immediately. Application via the other methods will take from four (4) business days to four (4) weeks to complete. You can apply for an EIN here:
https://www.irs.gov/businesses/small-businesses-self-employed/how-to-apply-for-an-ein

Estimated Tax Payments

Self-employed individuals should make estimated income tax payments on the net business income they earn quarterly. Otherwise, they may receive huge, unexpected income tax bills when their income tax returns are filed the following April.

Calculate Your Net Income

  1. Income
    Add all of the income (i.e., cash, checks, credit card payments, etc.) that you received during the quarter.
  2. Expenses
    Add all of the business expenses that you incurred during the quarter. You may ignore your vehicle mileage and Depreciation expense for now.
  3. Net Income or (Loss)
    Subtract your Expenses from your Income; the result is your Net Income. If the result is a negative number (i.e., a “Loss”), you can stop here; you won’t need to make any Estimated Tax Payments for this quarter.

Please refer to  Estimated Tax Payments.

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