I think this is a pretty common question. I've done a fair bit of research on the topic but lack experience; perhaps some of you who don't could help me out.
The question is: When a sole proprietor (Drupal Developer) starts doing steady business, should he/she:
- Get professional liability insurance?
- Incorporate as an S-Corp?
- Incorporate as an LLC?
- Stay a sole proprietor and just hope his/her contracts are waterproof?
Not looking for legal/tax advice exactly - more like legal/tax experiences :) and perhaps a bit about what factors of my personal situation would influence the optimal choice.
My turn...my research suggests that options 2 OR 3 PLUS the "good contracts" part of option 4 would be wisest. S-Corps and LLCs both cost $800 a year in California. Option 1, from figures I've heard, is at least over $1,000. On the other hand, I'm still not totally sure because I've heard that the "veil of limited liability" can be pierced more easily than one thinks. I've heard elsewhere that that is only true if you personally guarantee a contract, so it's a bit of a wash and kinda confusing.
So, before potentially taking the plunge...I am dropping a stone to gauge the distance. Just glaze over that analogy if it made no sense.
Thanks in advance.
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New Answer to an Old Question
The tax rule of thumb for opening an LLC/S Corp is the amount of income you generate as an independent contractor in the current year. If it is over $30K/year, then the tax savings will outweigh the costs of opening and maintaining LLC/S corp (btw, depending on where in CA you are, the amount might change).
From a tax stand point, I will explain to you how an LLC with S election will help you maximize your tax savings VS if you're to go the good ol' sole-prop route:
-Sole prop - less paperwork, BUT in addition to income taxes your entire income is subject to the self employment taxes (15.3%) as well. So if you're making $80K in 2015, then you will pay $12.240 just in self employment taxes (OUCH!).
-LLC with S election (aka S corp) is a great way to save a large chunk of your income from self employment taxes. With S Corp you are going to be viewed by the IRS as an owner and an employee of your own LLC. This allows you to pay yourself a "reasonable salary" as well as take out dividends (this portion will be shielded from the self employment taxes).
So let's add some numbers to this, if your contracts will bring you $80K in 2015, then you will pay yourself (approximately) $40K in salary, which is subject to the self employment tax $40K x 15.3%=$6.120. The rest of your income ($40K) will be taken out as dividends, which means you will be able to save $6.120/year in taxes.
There are lot's of variables when it comes to these things, so please do not hesitate to contact me. Our CPA firm works exclusively with independent contractors and self-employed, so we're no strangers to questions like these.
Darina Koltsova
480-426-1310
darina.koltsova@ictaxadvisors.com
www.ictaxadvisors.com