Like many freelancers and entrepreneurs, I’ve started out moonlighting on projects to supplement my income from my regular job. It was a great way to test the waters. However as soon as things started to pick up on that side hussle I was all in on self employment.
Before going full time on freelancing it was not worth thinking about taxes as much, but as I grew I learned ignoring them costs big! As long as I was earning less than $400/year I didn’t even have to report that income. However, once I choose to pursue self employment exclusively, it was time to take things seriously. I decided to take the formal step of establishing an LLC in my home state of Nevada. I’ve been told many times that this protects me in the event of legal troubles, however it also sets me up for major tax savings.
Now just because you set up an LLC doesn’t mean I instantly started saving on taxes, not by a long shot. I had eventually had to work with an accountant in order to set up my S Corp. An “S” what? A S Corp is a tax classification that allows me to be taxed differently by IRS. In my situation this added up to major savings.
For example I was earning $80,000 last year as an S Corp and paid about $12,000 in total taxes. Had I been taxed as a regular LLC my tax bill would have been closer to $17,000. That’s a $5,000 difference in my case
Before you look into the S Corp further, estimate your savings with this free S Corp Tax Calculator. It compares the difference between a regular LLC and one that chose to be taxed as an S Corp.
Sounds simple enough, doesn’t it? Sadly it’s not, which is why you probably need the guidance of a seasoned tax professional. Usually a CPA. If your LLC has complicated ownership and or lots of members I’d speak with a corporate attorney as well.
Keep in mind that if your business is not paying you that much in profits yet, an S Corp is not a good idea. S Corps take time and money to operate, for example you’ll need to pay a CPA to run payroll for you each quarter. However if you’re like me and your tax savings are in excess of $5,000 that’s a no brainer of an investment.
This tax classification has other restrictions as well for example you need to be a U.S. citizen. You also can’t have over 100 members in your business. Since it’s just me in my company those were not issues in my case!
One final note: the S Corp is very different from the C Corp. Most startups wanting to fund raise usually opt to be a C Corp because it makes that process easier. Not that you can’t raise funds with an S Corp, just that most investors aren’t going to be very familiar with it. Anyway the C Corp is usually not something most small businesses consider because the taxes can be quite high.