This is a question we get all the time. Working in California (I'll do my best to keep politics aside) we have to deal with extreme regulation and constant attacks on small businesses who are just trying to survive and grow. With the COVID 19 restrictions destroying our economies, many individuals are taking control of their own destinies and starting businesses. It is the only sure way to prevent others from dictating our lives.
That being said, business ownership is not for everyone. It is very hard work and you can most certainly kiss your free time goodbye. It takes a strong stomach and perseverance to see the light at the end of an increasingly dark and long tunnel. Focus on that light, stay the course, and surround yourself with a good team of like minded people and you will have the recipe for success.
So, this leads to the question at hand, should I set up a corporation or an LLC if I want to start a business. We always recommend every business start out as a sole proprietorship. Why? Because it is easy and requires little to no legal action on your part. You simply say, "I am in business today!" Go open a separate bank account (always keep your finances separated) and get to work. Here is a little hint, if you use your full name as the name of the business you do not need to file a DBA. Some banks will require a DBA to open a business account even if you are just using your name. (B of A is one of them). You can always shop around to a different bank or just open a regular consumer account, Remember, this is a trial run, don't go overboard right way.
When to choose an LLC or a Corporation
Tax planning aside for the moment, the big reasons one would choose an LLC or corporation versus a sole proprietor is for liability protection and the establishment of a separate entity other than yourself. Why liability protection? Seems obvious in lawsuit happy California. Although good insurance should be your first line of defense, liability protection is critical if you will be exposing yourself to risk. The last thing you want is to loose your house to a bitter client who is upset with the work you did.
To me, the bigger aspect is the creation of the separate entity. People are no longer doing business with you the individual, they are doing business with a separate legal entity. This entity has its own tax ID number and will (if treated as a corporation) file its own tax return. The assets of the company are owned by the company, you however, own the company. That separation is the biggest difference when forming a separate entity.
By now most people have heard of CA AB5, the Uber law. Voters overturned this insane restriction for private drivers but it is still impacting many other industries. People ask all the time how to get around this law. It's easy, incorporate. An independent contractor is an individual who does work for a company who is not an employee. This could be someone who (1) offers an unrelated skill, or (2) someone who does freelance work helping out now and then doing work that company employees normally do. AB5 made it illegal for companies to treat those who perform work that (2) falls under normal business practices as an independent contractor.
For example, John's Moving Company, Inc. gets busy moving people out of California to Idaho so John hires his friend Greg to give him a hand now and then. He pays Greg by check and plans to give Greg a 1099misc to report the expense. Greg would then file a Schedule C on his taxes and report the income as self employment income from working as a mover. Sounds simple enough right? "Not so fast", says King Newsom, Greg is performing duties in line with John's normal course of business and therefore must be treated as an employee. How do John and Greg get around this? Greg must form an LLC or Corporation.
With Greg doing business as Greg's Moving LLC, he can now do business with John's Moving Company, Inc. all he wants and the payments between them are between two entities. They can work away packing and moving the belongings of all those political refugees dreaming of a better life without worry. Greg will need to get his own insurance policy and any other licenses he will need to protect himself should there be any lawsuits against John while Greg is on the job. Greg would also be free to solicit work from other moving companies or start taking jobs on his own. See how all this works? Everything becomes a business to business transaction. The individuals are taken out of the equation.
This is obviously just the tip of the iceberg when it comes to making decisions regarding entity choice. There are many more factors to consider and a thorough discussion is needed to find out the best choice. As far as costs go, hiring us to set up an LLC or Corporation will cost between $1,000 - $1,500 including teaching you how to use it. You can expect to pay an additional $2,000-$3,500 a year for things like accounting software, payroll service, SOS fees, Franchise Tax, bookkeeping help, and tax preparation. Typical tax savings from operating as an S Corp versus a sole proprietor are between $5,000 and $10,000 a year for a company with $80k a year in profit. Yes, an S Corp more than pays for itself and will save you money on income taxes.
One size does not fit all. Seek out reputable professional help and for God's sake don't believe the garbage you read on the internet! They are just trying to sell you something you don't need!
Please contact our office if you are considering starting a business or if you fall under AB5 and want to continue working as an independent contractor. We will be happy to help!!!
James and Tiffiny