IRS 1040 Taxes

Should I Set Up a Company for Side Income?

Many Narrow Bridge Finance readers work on a side project or hobby outside of their main job to earn side income. While managing the finance for side income is only a small project early on, as the company grows it becomes more complicated. At that point, it is best to decide if it is worthwhile to create a legal company for business operations.

Benefits of Sole Proprietorship

If you earn money on the side, you automatically fall into the category of a sole proprietor. As a sole proprietor, any income you earn, less direct business expenses, is reported on your annual tax return on a 1040 Schedule C. The Schedule C lists your main revenue sources, expenses, and net income. For a small business, you are only taxed on the net income, not total revenue.

Starting a sole proprietorship is easy. It takes zero paperwork to start, so you don’t have to pay anyone or worry about the legal issues with filing. If you are a sole proprietor, all business decisions are up to you and you don’t have to report to anyone or produce extensive financial statements. As a sole proprietor, while you do pay income tax on the net income of the business, your business does not pay any corporate income taxes.

Risks of Sole Proprietorship

As a sole proprietor, all risks and liabilities fall on you. The owner assumes all legal and financial responsibility for anything that happens. If someone is injured due to your product or business, you are personally liable. If you bring on an employee and that person is injured on the job, you are liable. If your employee fails to perform or injures someone else, you are liable.

If we really think about it, we can come up with an almost infinite list of things that could go wrong that you would be liable for. Lucky for us, the government recognizes LLCs as a way to keep your finances simple and give you an extra layer of liability protection.

LLCs

An LLC is the best of both worlds. They are cheap and easy to set up (I have two), the financials are still reported on your own taxes via a Schedule C. It is important to keep your business finances separate from your own if you have an LLC. I have a checking account and PayPal account for both of my businesses. That allows me to more easily track income and expenses in one place. It also provides proof that my business is legitimate in the event a legal issue were to arise.

In Colorado, filing an LLC costs less than $100. In California, it is more than $700. Each state is different, so if you are interested in starting an LLC check with your state’s Secretary of State to find out the rules, costs, and how to get started.

What is Right For Your Business?

The decision is not black and white. If you are going to make a lot of money or have any possibility of legal disputes, you should set up an LLC (limited liability corporation) or corporation. If not, it is probably best to just operate as yourself (under a DBA, which stands for doing business as). If you have any questions, consult with a licensed lawyer or accountant to ensure you make the right decision for your business’s needs.

Do you have a company? How do you operate? Please share in the comments.

Originally posted November 19, 2008. Updated May 31, 2013. Image by Philip Taylor PT / flickr.

16 thoughts on “Should I Set Up a Company for Side Income?”

    1. That’s about what it costs here. Totally worth it for the extra professionalism and protection.

  1. I will eventually be setting up my LLC. I had one before for my online electronics company, but when I stopped the business, I didn’t want to pay the annual taxes that NC charges. Once I get enough revenue and start diversifying my income, then I will be setting it up. It is really easy and costs about $150 here.

    1. Are there extra taxes in North Carolina when you have an LLC? In Colorado, the revenue is generally treated as a pass-through (like a sole prop) unless you specifically opt to treat it like a C-corp for taxes, which gives you additional personal financial protections but takes a lot more work.

  2. It depends on what product/service you are offering and the level of sales expected. The sales tax collection and reporting requirements are significant so think carefully before setting up an LLC.

    1. In Colorado (and I thought everywhere), if you sell a product that requires tax, it doesn’t matter if you have an LLC or not. I don’t sell any physical products so have never worried about sales tax based on our state laws. For reporting, I use QuickBooks (I update it monthly) and print out a P&L at the end of the year for my accountant.

  3. I have an LLC that I started this year for all my online income. I track every expense through paypal and have a business checking account. $700 for filing an LLC in California! That is ridiculous! No wonder so many people are moving out of California. It only costs $125 in Florida.

    1. Here the LLC cost was only $50, so it was a no-brainer. At $700+ per year, I might not have an LLC. I have two, one for my flash mob business and one for my online blogging, freelance, and web design business.

  4. Bob @ Cubicle Sherpa

    I think an LLC is overkill for most people getting started with a side hustle. Here’s my reasoning. (Full disclosure, I now have an LLC, but I didn’t for my first two years)

    1. Worrying about LLC paperwork takes away energy from building your business. It’s one more thing you can do to feel like you’re a “businessman”, while putting off doing the hard work of getting your business off the ground.

    2. Many small business owners don’t know how to properly segregate their business finances from the rest of their life. They think an LLC will magically keep them safe and aren’t aware that piercing the corporate veil could still leave they personal assets at risk.

    1. Two very good points Bob. That separation between personal and business accounts is incredibly important to get the protection from an LLC. Just having the papers does not take care of everything for you.

      I also waited until I had been making money for about two years before forming an LLC for my blogging and media company. I did it quicker for the flash mobs because there is a bit more risk someone might get hurt during an event.

    1. It is quick and easy depending on where you live. I did it online in less than 30 minutes. It was intimidating before I started, but it is pretty easy now that I’ve done it.

  5. LLC’s can vary in price, you’re right. $700 seems quite high, but if people are running a business it’s important to consider setting it up as a company. Here in Illinois, it’s $300 I believe.

    1. I’m pretty good with finance and legal issues (more with finance due to my education), but i know enough to know that each situation is different and it is almost always a good idea to talk to a lawyer and tax professional before making big decisions like this.

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