Brad – My business is having a great year and I’m getting worried. I’m a sole proprietorship and my taxes could be really scary next spring. When should I make the leap to a different business structure?
Good question, Kelly.
Many businesses start out as sole proprietorships, which is doing business under your name and social security number— it’s the simplest, fastest way to charge customers for goods or services. More than 75 percent of American small businesses operate as sole proprietorships and a few remain that way forever.
As businesses grow, the tax limitations of sole proprietorships can become pretty painful. Paying income tax along with self-employment tax is a real burden, not to mention the risk you run while personally liable for all business debts and claims.
The next step for most businesses is to become a Limited Liability Company (LLC) or a corporation. In either case, a big part of the change is to minimize self-employment tax and instead pay taxes on the profits of the business. Other reasons include protection of personal assets, easier access to capital and streamlining the payroll process.
That leaves us with your big question: when?
We recommend making the switch as soon your business transforms from a hobby or side project to your primary source of income. A simple LLC structure helps you avoid liability and incorporation can offer significant tax benefits. And there is no reason to wait until you have five employees or pass any particular revenue threshold. In other words, go for it!