One of the most important questions a business owner will ask is, “What’s the best business structure?”
The answer, of course, is “It depends.”
Some of the factors to consider include: your business income/loss, your tax bracket without the business income, your exit strategy, your funding strategy, how risk averse you are and how simple you want to keep your plan (even if it means you pay more tax.)
So, it’s no surprise that we get a lot of questions about the right business structure at USTaxAid.com. Here’s one we recently received:
“My CPA says I’ll pay the same taxes whether I’m a Sole Proprietor or an S Corp. Also, I’m a contract Nurse, but didn’t get a 1099 last year or this year, but I always declare. Do I have to? What’s the likelihood of getting audited?”
Let me start with the last part first. Yes, you do need to report your income. If you don’t, you’re guilty of tax fraud and evasion. That can mean taxes, lost deductions, penalties and interest. If it’s bad enough, you could even face jail time.
That’s the bad news. You have to report it, no matter whether someone gives you a Form 1099 or not.
The good news is that you also get to take advantage of deductions you can’t take as an employee. Anything that is considered ordinary and necessary for the production of income could be a deduction. You may want to look at past articles here and on CashFlowAccounting.com for ideas.
Now, on to the business structure question. There are 4 reasons why I’m not a fan of the Sole Proprietorship
- You are personally liable for things that might happen in the business,
- You will pay more tax (self-employment tax of 15.3%) if you have income,
- You have a 1 in 3 chance of audit as opposed to a 1 in 100 chance of audit in an S Corporation, and
- You can’t build up business credit apart from your personal credit.
If you don’t have net income and all you care about is the tax, there is no difference between the S Corporation and Sole Prop. If you do have net income, the S Corp adds more complication with one more return and the need to set up and pay yourself a paycheck.