There are a lot of similarities between being self-employed and being a small enterprise proprietor. Each permit you to be your personal boss, for one factor! However within the eyes of the IRS, your formal enterprise classification can imply very various things relating to submitting your taxes and reporting your small business earnings.
Right here’s how one can decide which class you fall beneath as an entrepreneur and the way it will impression your taxes.
What’s the distinction between a small enterprise and being self-employed?
The best approach is to distinguish between being self-employed and being a small enterprise proprietor is to have a look at the way you run your small business. If you happen to’re a small enterprise proprietor, you run a enterprise and sometimes produce other folks working for you. If you happen to’re self-employed, you are the enterprise.
Examples of being self-employed:
- Sole proprietor: As a sole proprietor, you’re your small business. You name the pictures, work for your self, and take your small business earnings as private earnings.
- Unbiased contractor: As an impartial contractor, usually known as freelancers, you produce work for others, however you’re nonetheless your personal boss. You’re employed on a contractual foundation with shoppers of your selecting, however you aren’t their worker.
- Partnership: As a partnership, you’ve all of the qualities of a sole proprietorship, however you share possession of the enterprise with two or extra people who find themselves your “companions.”
Traits of being a small enterprise proprietor:
- You rent staff or produce other self-employed employees working for you as impartial contractors
- What you are promoting may be labeled as a separate entity, which means you’ve much less private legal responsibility
- You probably have part-time or full-time staff, you’re answerable for accumulating their taxes and acquiring employees’ compensation insurance coverage
How are taxes dealt with in another way?
Probably the most important distinction between small enterprise homeowners and self-employed people is the way you pay your self. Naturally, this additionally impacts how every pays their taxes.
In case you are self-employed:
- What you are promoting tax deductions, earnings, and losses are reported in your private earnings tax return utilizing Schedule C
- If you happen to make greater than $400 per yr, you’re answerable for paying self-employment tax to cowl your Medicare tax and Social Safety contributions
- You may pay quarterly estimated taxes all year long to keep away from any penalties or a big tax invoice on the finish of the yr
In case you are a small enterprise proprietor:
- Small companies are taxed in another way primarily based on your small business kind — for instance, restricted legal responsibility firm (LLC) taxes may be handed by way of to the homeowners, or you possibly can elect to be taxed as an organization
- In case you are taxed as an organization, you’ll pay company taxes, which is a tax in your earnings (your income minus the price of items bought and different enterprise working prices)
- You utilize Type W-2 to report your staff’ incomes and the way a lot federal, state, or native earnings tax they’d withheld
- If you happen to rent impartial contractors, you have to report any funds of $600 or extra utilizing Type 1099-MISC or Type 1099-NEC
When ought to I transition from being self-employed being to a small enterprise proprietor?
As your small business grows, many self-employed folks begin questioning when they need to create a proper enterprise entity.
You may wish to contemplate altering your small business construction if:
1. You wish to reduce your private legal responsibility.
Let’s say you’re a sole proprietor who experiences your small business bills utilizing Schedule C. Currently, your small business bills have been rising. You end up including extra property to Schedule C when submitting.
On this case, it may be a good suggestion to restrict your private legal responsibility by structuring your small business as a single-member LLC for tax functions. In doing so, you’re forming a enterprise entity separate from your self, providing extra legal responsibility safety.
When you’ve executed this, you possibly can elect to tax your small business as an S company and begin utilizing Type 1120-S to report enterprise earnings and losses.
2. You’re including further homeowners or staff.
Possibly you’ve been using solo as a sole proprietor and are contemplating including extra homeowners to turn into a partnership or LLC. Or maybe you’ve been in a partnership with another person who has determined they wish to depart. Regardless of the case, a change in possession can usually result in a change in enterprise construction.
Likewise, including staff can imply extra legal responsibility, offering you with one other good purpose to change your small business kind.
In the long run, deciding to vary your small business construction simply comes down to what’s finest for you — and your small business!
