If you’re a freelancer, you may be wondering how the newly passed Tax Cuts and Job Act (TCJA) affects you as a business owner.
Yes, it’s beast of a bill and there is certainly a lot to digest — it is nearly 500 pages, after all. And while the old tax code is still in effect for 2017 (the TCJA doesn’t apply until next year), tax pros and everyday tax-paying citizens alike are trying to make sense of it all.
For starters, it might be to your benefit to set up your business as an LLC. You may also want to run your business entity as an S-Corp. Here’s the lowdown on how these business structures can offer significant savings when it’s time for you to file taxes. You can also use this guide to decide whether forming an LLC is the best move for your business.
What's the biggest benefit of an LLC and an S-Corp?
Although the terms LLC and S-Corp are often used interchangeably, it’s important to realize that forming an LLC does not automatically make your business an S-Corp, explains Katherine Pomerantz, owner and chief bean counter at The Bookkeeping Artist. If you want to form an S-Corp, you need to specifically elect to do so.
And, here’s where it gets good regardless of which of these business structures you choose: behold the pass-through entity.
Pass-through entities can be LLCs, LLCs with an S-Corp election, or partnerships. These types of business structures allow companies to earn profits that aren’t subject to income tax. Instead, the income tax “passes-through” to the company’s owners, who are taxed individually on the income. So, if you’re the only owner of your LLC, you don’t have to file a business tax return. You only need to file taxes as an individual.
While individuals can be taxed up to 39.5 percent in 2017, the TCJA lets business owners take advantage of a 20 percent deduction of their pass-through income. For many business owners, this is reason enough to set up shop as an LLC.
How to set up an LLC
Thinking about setting up an LLC? The good news is that the application process for doing this is relatively simple and can be completed online, says Pomerantz. LLCs are formed by state statute, meaning the rules governing them are controlled by local governments. For this reason, you’ll have to visit your state’s Secretary of State or Secretary of Commerce website for the low-down on particular fees and guidelines.
A few things to consider
Note that while setting up your business can net robust tax savings, there are costs to consider. Besides going through the trouble of setting up an LLC, or an LLC with an S-Corp election, you’ll need to pay an annual fee. These fees vary by state and can run you anywhere from $50 to $800 a year.
Plus, you may need to factor in ongoing accounting expenses, such as setting up and paying for a payroll service. You may also need to hire an accountant to handle the extra paperwork come tax time, explains Pomerantz.
Other downsides? You may have to pay more in other types of taxes. About half of all states have some sort of franchise, business, or excise tax, so be sure you understand your full tax obligation before you change your business entity, says Pomerantz.
“State tax law may not treat your S-Corp as benevolently as the IRS,” she says. “For example, California imposes a 1.5 percent franchise tax on S-Corp net income with a minimum of $800 annually.”
This means you’ll need to pay at least $800 just for the honor of operating an S-Corp in California, says Pomerantz.
Should you set up your side hustle as an LLC?
The answer really depends on how much you earn from your side hustle. Pomerantz suggests that you should be raking in at least $40,000 of net income after expenses to make it worthwhile. So, if you have a side hustle that’s really helping you stack the Benjamins, it may be worth the costs.
Another thing to keep in mind is that if you’re also an employee at another job, this can mess up your tax withholding, explains Pomerantz.
“Since your two employers do not collaborate, your two incomes combined may bump you to a higher tax bracket and result in too little being withheld.”
How to get expert help
Curious if setting up your business as an LLC or S-Corp is right for you? It’s a good idea to first talk to some experts and have them weigh in. For starters, you can get free advice by setting up an appointment with a mentor through SCORE, a nationwide non-profit that provides free education and mentorship to small business owners.
You can also seek out a tax professional, such as an accountant or CPA. Likewise, you may want to consult a lawyer, who can help ensure that you’re meeting other legal requirements, explains Pomerantz.
As in all things in life, there is no one size fits all answer to setting up your business as an LLC. So, before changing your business to an LLC or an LLC with an S-Corp election, be sure to carefully weigh the costs and benefits to gauge whether it’s the right move for you.
Disclaimer: This article is not intended to replace the advice of tax or legal experts. If you have questions, please consult a professional.