Should I create an LLC for 1099 sidework?

[luk3thomas]

Hi all! I recently had a rather large tax bill from my 1099 sidework. It got me thinking. What can I do to strategically lower my overall taxes while putting myself and my family in the best financial situation?

I've talked to a few people about creating an LLC. Everyone says create an LLC so clients cannot touch your personal assets in legal settlement. I've been hesitant to create an LLC because I think it would add unecessary complexity to my life.

* Should I create an LLC?

* Where should I incorporate?

* Should I do a S corp or C corp? I have no idea, my tax lady mentioned something about big C and little C corps.

* How does having an LLC affect my taxes?

* Should I be a W2 employee of the LLC?

Please share any learning resources I might find helpful. Thanks!

[smileysteve]

* Should you create an LLC? It's a pass through tax entity, and as an individual developer, you are not abstracting much liability here.

* Should you incorporate? Maybe, see the next point.

* You should consider an SCorp, your overall payroll tax liability can potentially be reduced. You should talk to your tax lady more.

* LLC does not affect your taxes much. You will have an additional ScheduleK to file each year.

* Should you be a W2 employee of the LLC? If you're an owner and employee, you need to not be w2. If you form an SCorp you should make yourself w2 and pay yourself a minimum reasonable market salary (i.e. 100k instead of 200k) year. You can then dividend yourself the other 100k, which will save 15% (payroll tax) and potentially move your income into capital gains instead of payroll tax.)

Other advice, make sure that you look into all deductions you may be able to receive (especially if you don't have benefits through another employer). This includes health insurance, retirement, benefits, use of car (it's a meeting not a daily commute if you travel onsite), use of house / office, domain names, server costs, business equipment (new laptop / mobile devices), and business services (part of your cell bill, part of your internet).

[loumf]

The whole W2/SCorp thing you are talking about is a commonly held belief, but there are details you are getting wrong that change its efficacy.

1. There is a maximum income for the payroll tax which in 2014 was 117,000. Which means that in your example (making 200k and only paying on 100k), would not save them tax on 100k. They would only have needed to pay on 117k. So they are saving payroll tax on 17k, which isn't worth the trouble.

2. This person has a regular job. Lots of engineers already make more than 117k, so they might already be maxing the payroll tax. In that case, they save nothing.

3. The way that many try to game the system is to try to report that the "reasonable market salary" is low -- which might work if you don't already have a job doing what your 1099 work is. If you do, you might have a hard time explaining that to the IRS. If you only do 1099 work, you can site labor statistics (and the median might be in your favor).

The whole SCorp thing that you see recommended works best if you

1. Make near or more than the payroll max (117k)

2. Live in an area of the US where the median developer salary is low, say 50k.

3. Do not have a long salary history of making a lot more than that in that area.

In that case, you save the payroll tax on 117k-50k. Even if you make 200k, you only save the tax on 117k-50k.

I am not an accountant, and this is not accounting advice.

[smileysteve]

Thanks for pointing out those issues, especially given my example.

One thing upon further thought on the 117k. Self employment and W2 in an Scorp involve paying both the employee portion and the employer portion. ~15%. The 117k limit applies only to the employee side and only to social security (not medicare/OADI).

Beyond payroll taxes, it is possible that the Scorp might be able to have some income below the additional ordinary income on tax rates. (Mostly on true if the Scorp can keep its income below 34% rate (at the ordinary income rate ~ 28% at 90-180k)

I am not an accountant, and this is not accounting advice.

[loumf]

Self employment tax (the equivalent of the employer side in W2 work) does max out at 117k.

It's complex, and I think that someone doing sidework would not benefit enough from an scorp to make it worth it. Someone doing it fulltime that makes a lot and can claim low normal wages should look into it.

[loumf]

Establish a solo 401k and SEP (I believe it's too late for 2014, but hopefully you will have this "problem" in 2015). You can sock away money pre-tax, which will lower your bill now.

I am not an accountant, but my wife is, and she thinks you could do a SEP for 2014 (but this is not accounting advice). http://www.irs.gov/Retirement-Plans/Plan-Sponsor/Simplified-... -- if she's right, you have until 4/15.

You could also max out a Roth IRA.

Go through your expenses for 2014 very carefully and think about what is a business expense.

I very much doubt that forming any kind of corporation will help you tax-wise, especially if you make a decent regular salary. Most of the benefit comes from avoiding FICA on a portion of your salary, but you might already be maxing FICA in your day job, so this is meaningless. It's also going to be hard to claim that the "reasonable salary" for what you do is less than you make in your day job (rate-wise).

[cirdoc98]

Single member LLC (disregarded entity) is the way to go, setup a separate bank account and bookkeeping so that you are treating as a legitimate business. In CA it cost me around $800 to form with a tax attorney, and the min state tax is also $800/yr. All worth it for the peace of mind that you have at least some protection if 10yr from now someone tries to sue you for whatever reason.

[jayess]

Forming an LLC alone will not change your tax situation. The default rule the IRS imposes on a single-owner LLC is that it is treated as a "disregarded entity," meaning that for tax purposes, it's as if the LLC doesn't exist. You still report your income/expenses on 1040 Schedule C.

You can elect to change the default tax treatment of your LLC and treat it as an S corporation or C corporation.

An S corporation can have slightly different treatment for your income. You can separate your earnings into a salary and regular distributions. Your salary would be taxed at the traditional W2 rates, meaning all of the traditional payroll tax rates. Depending on how much the company brings in, the only savings would be on the "distributions," which are not subject to self-employment tax or other payroll taxes. Distributions are taxed at regular income rates (the traditional income tax brackets). But beware that the IRS scrutinizes S corporations for abuse of this arrangement, so you need to pay yourself a "reasonable salary" before you make distributions. The IRS doesn't have a bright-line definition of a reasonable salary, so you need to be reasonable. :)

The other option is to be taxed as a C corporation, which can have tax benefits and negative consequences. C corporations are subject to double taxation, meaning that the corporations net earnings are taxed at corporate income tax rates. Any dividends that you pay yourself are also subject to dividend tax rates on your personal income tax (15%). But -- if you can keep your corporation's net income below $50,000, the corporate tax rate is only 15%, much lower than usual individual income tax rate for many people. But then you still need to pay yourself a salary if you are a corporate officer and want to get paid for the work you are doing, which again triggers w2 payroll taxes. If you want to keep your corporate earnings inside the corporation to build up capital, you can shield those earning from the dividend tax. But, if you begin to accumulate too much, there's a tax for that too. C corporations can be a legitimate way of reducing your tax liability, but you just need to understand the rules.

The bottom line is that a single-owner LLC taxed as a disregarded entity is the simplest way of handling things. You'll get a 1099, yes, but that's life. In some states an LLC is expensive to form, in others it's cheap. I personally think that an LLC is nice to have -- it gives you some more credibility than just being an individual contractor. It likely wouldn't provide a ton of liability protection because you are personally doing all of the LLC's work, so a good attorney would make the case that the LLC is really just an alter ego. But then again, that's what insurance is for too.

And, if you do decide to form an LLC, just do it in your own state. Forming a Delaware or Nevada LLC is a waste of money and it subjects you to the law of two states (Delaware and your state). Forming the LLC in another state provides no benefit whatsoever for 99% of businesses.

[tptacek]

I'm not a lawyer but the last time I looked into this, alter ego liability relied on you intertwining the finances of the LLC with your personal finances; paying the rent from the LLC's business bank account, for instance.

[logn]

Generally that's the case. Specifics vary by state: http://www.nolo.com/legal-encyclopedia/single-member-llcs.ht...

(not a lawyer)