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.
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.