Have you ever consider the legal/tax status of your business? If not, you might be surprised of what a difference it can make.
Businesses can have many different legal and tax forms. For many this is confusing so I will try to explain the best way I can.
For taxes purposes your business can be classified as a:
Depending on how you choose to classify your business how much taxes you will pay and how you will be taxed.
A sole-proprietor kind of business gets taxed the same you do. Your business and you are the same thing taxes wise. That means that your business income is your income, and you will pay full taxes (including self-employment taxes) on the income you make from it.
An S Corporation is a different entity from you, but, the profit from your business gets rolled-over to your personal tax income. With an S Corporation, you can choose to pay a salary to you, which can be less than your actual profit. Your salary will get taxed as any other salaries do. The leftover profit won’t pay as much taxes as your salary income does (since it won’t pay self-employment taxes: social security and Medicare). The left over profit will only pay the corporate taxes, and not the personal taxes. Although that will reduce your tax bill, you will be reporting less personal income than you would as a self-proprietor (because part of it would be your company’s income), but your retirement contributions will also be lower. More money today but less in the future.
As a C corporation you are a separate entity from your company, and your company will be taxed a bit differently from an S Corporation. As a C Corporation the business income doesn’t automatically go into your personal tax return. A C Corporation can choose not to distribute dividends, in which case that income won’t go to you, it will stay with the business and grow the value of it. If the C Corporation distributes dividends, you will be paying the corporate tax for those profits and then personal income taxes on the dividends distributed to you.
Most Face Painting business ran by only one person will be in either the first or second category. A C Corporation is usually an option geared to bigger companies.
If you have a few painters working for you on a regular bases, and you pay them a salary (they are not just random sub contract labor), an S Corporation might be a better fit for your business.
Legal wise, your business can assume different forms. We will look into the 2 most common ones for a small business: LLC and Sole Proprietor.
A Sole-proprietor kind of business is not a different entity from its owner. You are the business, and you are legally responsible for whatever your business does. As an example, this means that if you get sued and loose, your personal possessions (car, house, furniture, etc) could be used to pay the person that sued you.
As an LLC you and your business are consider different legal entities. This is a great way of protecting your personal possessions (and your family) from whatever could happen with your business. Keep in mind though, that just filing to become an LLC doesn’t give you the protection you are looking for. You must behave as an LLC if you want to be protected.
That means that you need to distinguish between your computer and the business’s computer, your credit card and the business card, etc. If you constantly buy personal things (eg: groceries) with your business card, or have no separate accounting for your business, you are likely to lose that LLC protection in a court setting.
Keep in mind that your legal status differs from your tax status. You can be an LLC and still file taxes as Sole-proprietor if your LLC has only one member. Choosing to file as an S Corporation might have some tax advantages but it requires more paperwork.
Make sure to contact a CPA to see what the best option for your business is. They can also give you guidance on how to file for these legal and tax status.
Disclaimer: these are opinions based on our personal experience, we are not lawyers or CPA’s, so we recommend for you to contact a lawyer and or CPA before making any decisions. We are not in any ways giving legal or tax advice and we are not liable for any decisions you make or stop making based on the opinions provided above.
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