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Maybe you have a side hustle that's turned into real money and now you're asking yourself, should I set up a LLC?
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Hey everybody, hope you all are having a blessed day. In this video, let's go over an idea. Maybe you have a side hustle that's turned into real money and now you're asking yourself, should I set up a LLC? Can I go the escorp route or should I continue to run my business as a sle proprietorship?
Well, today I want to discuss some of the common ways you can classify a small business. Hi, my name is Prince Chenou. I work at a big finance institution and I come on here and create videos to make all things personal finance simple, practical, and accessible for everyday people like yourself. In this video, I'm going to break down the differences between a sole proprietorship, an LLC, and an escorp.
I'll walk you through what they actually mean, how they affect your taxes, your liability, or which one might be the best fit depending on your business. So, if that sounds interesting to you, let's get into it. So let's start off with the sole proprietorship. This is the simplest and most common way to run a business, especially if you're just start getting started.
If you're earning money on your own, whether through freelancing, selling products, or offering a service, and you haven't registered a formal business entity with your state, then by default, you're operating as a sole proprietor. You're the sole owner, and there's no legal separation between you and the business. That means all the income, expenses, and profits from the business directly flows onto your personal tax return.
Some of the advantages of I bring sole proprietorship includes the following. One, no formal paperwork is required. This means that you can begin offering your products or services immediately without needing to register a separate business entity with the state. Two, simple tax filing. As a sole proprietor, you op you report business income and expenses directly onto your personal tax return using schedule C.
You don't need to go through the hoops and hurdles of filing a separate tax return for your business. Three, complete control over your business. As a sole owner, you make all decisions independently without needing to consult with partners, shareholders, or board of directors. There's definitely pros and cons to having that sort of flexibility.
So now let's talk about some of the cons of operating as a sole proprietor. For one, there's very there's a lot of risk because there's no personal liability protection. One of the biggest drawbacks of a sole proprietorship that there's no distinction between you and your business. If your business is su or falls into debt, your personal assets such as your car, home, or even your savings could be at risk because you're personally liable for everything the business owns.
Two, you're responsible for paying self-employment tax on all profits. As a sole proprietor, you don't receive a paycheck from your business. So, you're required to pay the full 15.3% self-employment tax. This covers both the employer and the employee portion of Social Security and Medicare. And remember, that's in addition to your regular income tax.
Three, there's limited credibility and access to funding. Since the sole proprietorship isn't registered business entity, it may be harder to establish credibility with banks, vendors, or potential clients. This can make it more difficult to qualify for business loans, secure contracts, or even be taken serious in some form of business settings. So, really, operating as a sole proprietorship is best if you're testing the waters with a side hustle or freelancing gig.
But once money starts rolling in, there's even a hint of liability, you want to upgrade. So now let's talk about limited liability company or LLC. An LLC is one of the most powerful business structures for small business owners and that's for a great reason. It's a legal entity that separates you from your business.
Meaning your personal assets are not are you usually protected if something were to go wrong. Think of it like building a legal bubble around your personal finances. If you're starting to take your business more seriously, maybe you got steady customers or reoccurring revenue or you're taking on more risk, setting up an LLC might be the best next step.
So, what are some of the benefits of forming an LLC? One, personal liability protection. One of the biggest reasons people form an LLC is to protect their personal assets. If your business is ever sued or goes into debt, the only only the business assets are at risk, not your home, your car, or your personal savings.
That legal separation gives you a lot more peace of mind. Two, flexible tax options. By default, if you're a single member LLC, you are taxed as if you are sole proprietorship. Everything flows to your personal tax returns. But there's cool parts. You can also choose to be taxed as a S corp or even as a C corp later on.
This gives you more flexibility as your business grows and your tax situation becomes more complex. Three, it makes your business look more legit. Having an LLC after your name can add a level of professionalism. It shows clients, vendors, and banks that you're taking the steps to formally set up your business, which can help you with things like getting approved for a loan, open up a bank, business bank account, or signing contracts.
Now, with that being said, there is some downside though for forming LLC. Forming LLC isn't free. There's some startup and maintenance costs that comes with it. You'll need to register with the state, which typically costs around anything from $50 to upwards of a few hundred. Some states also require you to file an annual report or pay ongoing fees to keep your LLC in good standing.
Another thing is that you still have to pay the self-employment tax unless you change your tax status. Just like a propri sole proprietorship, if you don't make any tax less, you're you're owed the selfmployment tax on all profits. The only way to get around this to like to be taxed as a escort, which we'll go over next.
So, who is an LLC good for? If your business is bringing in in steady income and you want to protect your personal asset, forming an LLC is a great move. It gives you the best of both worlds, both legal protection and tax flexibility without being overly complicated and often is the next step once your business outgrows the sole proprietorship stage.
Now, let's get into S corporation or escort for short. This one confuses a lot of people, so let's let's clear it up right now. An escorp isn't a type of business structure. It's a tax election that you make with the IRS. You could choose to have an LLC or corporation tax as ESCORP to potentially save money on self-employment taxes.
The main reason people go with this route is to be more tax efficient once your business is generating consistent profits. So, here's how it works in simple term. where you become an escort, you're required to pay yourself a regular or a reasonable salary. That part is taxed as a regular W2 income. There's nothing new there.
But any profit that you make beyond that salary, you can take those as distributions and those are not subjected to the self-employment tax. That's where the tax saving comes into play. Some of the advantages of switching to a S corp includes bigger tax savings on the back end. By splitting your income into salary and profit distribution, you're avoiding paying self-employment tax on the distribution portion.
That's 15.3% savings that can add up quickly if your business is making good money. Also, you still get the liability protection if your business is already an LLC or a corporation. Making an escorp election doesn't change that. you still keep the legal separation between you and your business which means that your personal assets are protected.
But of course there's some se there's some drawbacks. One of the things that you are required to run payroll as a escort you are technically both the owner and the employee. That means that you have to set up payroll pay yourself a salary withhold taxes and issue issue yourself a W2. Most people end up using payroll services to keep things compliant, but that's an added expense and in an extra step.
Moreover, there's more admin and tax work. ESCORP have to file a separate business tax form 1120S and depending on how complex your business is, you may need a CPA to help you out. It's definitely more work compared to a sole prop or a standard LLC. And then lastly, there's rules around who can qualify.
To elect for escort status, you have to be US citizen or resident. You can't have more than 100 shareholders, and you can only issue one class of stock. That's usually not a problem for solo business owners, but it's something to be aware of. So, who should consider becoming an S corp? If your business is bringing in consistent profits, usually at least 50 to $75,000 or more a year, and you're ready to handle a little bit more paperwork in exchange for some serious tax savings, the escort route might be worth it.
But if your business is still new, inconsistent, or not quite profitable yet, you're probably better off sticking with the regular LLC until you're ready. So now sum summarizing everything we've talked about, let's talk about how to decide which one makes the most sense for you based on whether where you are within your business journey.
If you're brand new in business, maybe you just started selling some handmade candles online or offering freelancing consulting or picking up ride share gigs like Uber or Door Dash, sticking with a sole proprietorship is perfectly fine for now. is simple, low cost, unless you test out the business idea without the upfront paperwork or legal complexity.
But keep in mind, it's not meant to be a long-term structure if you're planning to grow and take on any risk. If your business is starting to bring in real consistent money and especially if you're working with customers regularly or offering services that carry some risk, forming an LLC is probably the smart next move.
It gives you personal liability protection, a more professional appearance, and the flexibility elevates your tax structure as your business grows. And finally, if you're full-time your business, the profits are steady, and you're earning at least 50,000 to 75,000 or more in net income each year. That's when it makes more sense to talk to your CPA or tax professional about switching to a escort.
At that point, the potential tax savings can be significant and the added complexity may make more sense. Honestly, I hope this video helped somebody out there. Thank you for watching. Please let me know if you have any questions, any comments, and I hope you all have a blessed day. Thank you.
This video is for general educational purposes only and is not personalized investment, tax, or legal advice. Every situation is different. Talk with a qualified professional about your circumstances before acting. PLC Wealth Partners is a registered investment adviser. See our disclosures.
