Setting up a Side Business Can Be Risky Unless You Do it Right
In the post-recession economy, people are more likely than ever to not rely totally on their employer for income. Side businesses that people do while employed full-time are becoming increasingly common. But while having a part-time entrepreneurial business can be a great idea, it can be risky if you don't do it right, according to CPA Michael Hanley, who specializes in working with small business.
"The #1 most overlooked tip by people running side businesses is that they fail to setup a business entity because they still view their business as a little side business that they will incorporate when things take off," Hanley says. Hanley outlines why this is the most detrimental mistake that a side business owner can make.
Sole Proprietorships (the business structure you default to if you fail to setup a Corporation, LLC, etc) are subject to the highest audit risk out of all the business structures. The reason for this high audit risk is that all Sole Proprietorships report their business income and expenses on Schedule C (the second most highly audited form that you can attach to your tax return). By setting up an S Corporation, you become nine times less likely to be selected for a random IRS audit (audit risk decreases from 2.7% to .3%, making it very possible that you can go your entire life without ever being selected for an audit).
Sole Proprietorships are subject to the highest tax rates. As a Sole Proprietor, you end up paying your regular income tax rate plus an additional 15.3% Self Employment Tax.
This means that if you are in the 25% tax bracket, you are essentially paying 40.3% tax. S Corporations typically enjoy a lower tax rate due to payroll taxes taking the place of Self-Employment Taxes. So, if you are in the 25% tax bracket, you end up paying somewhere between 25% and 40.3% depending on the nature of your business, profit levels, etc.
Operating a Sole Proprietorship means that your personal assets are completely exposed during your business operations. If someone sues you for a business related matter, you could end up losing your house, your savings, your retirement, and everything else you own. By setting up an S Corporation, you protect your personal assets from business related lawsuits and all you can lose are the business assets.
By failing to setup your Corporation right from the start, you lose valuable credit-building time. Banks, credit card companies, and other lenders will not lend unsecured funds to Corporations within their first two years in business. They will either lend to you and allow you to use the funds for business purposes or they will lend to the business as long as you are willing to attach a personal guarantee. If you incorporate right from the start, when you are ready to turn your side business into a full business, you may already have this two year period behind you and you can start looking for business loans and business credit cards.
"The #1 most overlooked tip by people running side businesses is that they fail to setup a business entity because they still view their business as a little side business that they will incorporate when things take off," Hanley says. Hanley outlines why this is the most detrimental mistake that a side business owner can make.
Sole Proprietorships (the business structure you default to if you fail to setup a Corporation, LLC, etc) are subject to the highest audit risk out of all the business structures. The reason for this high audit risk is that all Sole Proprietorships report their business income and expenses on Schedule C (the second most highly audited form that you can attach to your tax return). By setting up an S Corporation, you become nine times less likely to be selected for a random IRS audit (audit risk decreases from 2.7% to .3%, making it very possible that you can go your entire life without ever being selected for an audit).
Sole Proprietorships are subject to the highest tax rates. As a Sole Proprietor, you end up paying your regular income tax rate plus an additional 15.3% Self Employment Tax.
This means that if you are in the 25% tax bracket, you are essentially paying 40.3% tax. S Corporations typically enjoy a lower tax rate due to payroll taxes taking the place of Self-Employment Taxes. So, if you are in the 25% tax bracket, you end up paying somewhere between 25% and 40.3% depending on the nature of your business, profit levels, etc.
Operating a Sole Proprietorship means that your personal assets are completely exposed during your business operations. If someone sues you for a business related matter, you could end up losing your house, your savings, your retirement, and everything else you own. By setting up an S Corporation, you protect your personal assets from business related lawsuits and all you can lose are the business assets.
By failing to setup your Corporation right from the start, you lose valuable credit-building time. Banks, credit card companies, and other lenders will not lend unsecured funds to Corporations within their first two years in business. They will either lend to you and allow you to use the funds for business purposes or they will lend to the business as long as you are willing to attach a personal guarantee. If you incorporate right from the start, when you are ready to turn your side business into a full business, you may already have this two year period behind you and you can start looking for business loans and business credit cards.