One of the most difficult parts of self-employment — besides landing consistent clients — is making sure that you’re paying the right taxes. What does it mean to “pay the right taxes?” First, you need to make sure that you create the proper type of corporation and tax election so that you fit into the correct self-employment tax brackets.
No matter what company structure you choose (we outline some of the different options below), you must pay various forms of taxes. We already shared everything you need to know about tax when you’re self-employed. We’ve also outlined seven types of taxes you should know about. Now, let’s take a closer look at the levels of incorporation maturity, the different types of self-employment tax brackets, and what kind of tax you must pay on them.
Self-employed on Schedule C
This category of incorporation is for self-employed folks who do not have their own company. Independent contractors that use their own social security number to declare your income fit into this tax bracket.
This is the simplest quickest, and cheapest upfront method to do freelance work in the United States. You won’t have to pay any fees unless you file for a Fictitious Business Name (FBN). An FBN is a business name that does not include your first or last name (this costs less than $100). That said, there are quite a few downsides to working this way:
- No tax advantages. You will almost certainly pay significant taxes — needlessly (more on that later)
- No legal protection in case of bankruptcy
- Doesn’t look professional (no LLC or Inc. in the name)
- Doesn’t allow for W-2 payroll and other optimized financial configurations as all fall under 1099 independent contractor income
When it comes time to pay taxes, as a sole proprietor you must fill out an IRS Schedule C form. This indicates how much money you made (or lost) in your business. Self-employed, solopreneurs, independent contractors, and side hustlers typically attach this form to their 1040 form when they file their taxes. You don’t have to use this form if you’re a C Corporation or S Corporation.
Single-member Limited Liability Corporation
Another way to declare your income as a solopreneur is to open a single-member Limited Liability Company (LLC). These types of companies are very easy to open and maintain. There is also no additional tax return to fill out in most states. This means that your CPA and advisor fees are far less. They only allow for a single owner — hence the single-member moniker. You can also add your spouse as an owner in most states.
In many cases, your LLC can (and should) be taxed as an S Corp. Remember: an S Corp isn’t a type of business (like an LLC), but rather a way to determine the way your business is taxed. It is an election status you make with the IRS. It modifies how the IRS views your company for taxation purposes. You’ll be able to avoid double taxation as opposed to a C Corp. It’s a tax status that will help you (legally and uncontroversially) minimize the required self-employment tax. This is the Federal Insurance Contributions Act (FICA) tax, which contributes to Social Security and Medicare benefits. There is a straight 15.3% tax on all net income in a business or 1099 sole proprietor classification
Income in an S Corp or LLC with an S Corp election is a dividend (sometimes owners disbursement) instead of as owners’ pay/earnings. This is key to helping you avoid the 15.3% self-employment tax. When you sign up for this tax election, you are an employee of your own company. That said, you must compute and pay just wages. This also requires you to pay self-employment tax. However, a significant portion is often re-designated as dividends or owners’ disbursement. This can potentially help save you a lot on taxes.
We specialize in these types of solopreneur businesses — reach out if you need assistance in setting up an LLC as an S Corp, or if you want to know how to change your existing LLC into an S Corp. We know these can be murky waters, and we’re here to help you navigate them!
When you elect S Corp tax status for your single-member LLC, you tell the government that you shouldn’t be considered self-employed. As such, your business is not required to pay the federal self-employment tax. Again, this process can be a bit confusing — don’t hesitate to contact us for help.
Advanced types of corporations
If you’re hoping to take your corporation up a notch, there are a few different options. Keep in mind that all of the following corporations require a lot more maintenance than Schedule C self-employment or single-member LLC S Corps.
C Corps are corporations that earn over $200,000 in net taxable income. They offer tax advantages, but maintenance is the highest of any other type of business. It presents many opportunities in terms of tax planning. If you’re hoping to land investors, most venture capitalists prefer to invest in C Corps. We normally only recommend opening one if you know that your business will net at least $150,000 – $200,000 every year for multiple years, predictably.
Partnerships and Limited Liability Partnerships (LLPs) are very complex. LLPs in particular offer the benefits of an LLC with the possibility and flexibility of a partnership. It’s best for folks who want to go into business together, but one owner hopes to be more passive (no management responsibility, a lower liability). Again, these are some of the rarer types of businesses. They also incur a lot of advisory and compliance overhead.
Wrapping it all up
If you recently started your solopreneur journey and aren’t sure what type of taxes you should be paying, we’re here to help. The world of business ownership is rewarding, but that’s not to say that it can’t be overwhelming at times.
When you leave your taxes to experts like us, you’ll be able to breathe easier and focus on what matters most — building your business! Contact us today so that we can determine how best we can assist you.