It is always recommended that you get liability protection if you are engaging in trade or business for the purposes of making money. And the tax law is surprisingly generous when it comes to classifying a “hobby” as a business, as long as you meet certain requirements.
Having a side business has the potential to create substantial tax savings that you can garner against your normal, ordinary income. Whether you form an LLC, S-Corp, or C-Corp largely depends on the amount of money you intend to make, how much you’re willing to spend each year on keeping up the company, how much documentation you want to do each year for the company, and certainly the state you live in. Your long-term intentions can also come into play, though most of the time switching from one type of company to another is a relatively simple proposition.
- LLC’s are most often the most simple and least expensive of the three. They require small fees to setup and even smaller fees to keep up each year. There is very little documentation required to comply with law and to receive the liability protection and tax benefits enjoyed by the LLC.
- S-Corporations are almost always more expensive and time consuming to maintain. Like C-Corporations, they need to have annual meetings and keep written minutes of such meetings, among other legal requirements. They can have some tax benefits over LLCs, but usually those benefits do not come into play until the owner(s) begin to make a substantial income.
- C-Corporations are the most complex and expensive of the three. Also they subject the owner(s) to double taxation. The corporation is taxed, and then the owners are taxed on the corporations’ after-tax profits. C-Corporations are most often used by professionals such as attorneys or physicians, or by businesses looking to raise capital while maintaining smooth and frequent transfers of ownership of the business (e.g. shares of stock).
This is a brief summary, but if you are engaging in a side-business or a full-time business, or considering doing so, you need to explore setting up an LLC or corporation for both liability protection and tax benefits. You may be very surprised at how many tax dollars you could have been saving if you had done it sooner!
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