How best to structure your business is one of the first important decisions a small business owner has to make. Whether you operate as a sole proprietorship or form an LLC depends on a lot of different factors—including assets you own that need protecting, number of employees, annual revenue and tax considerations. However, recent tax changes in the American Rescue Plan may make small business owners who operate as sole proprietors rethink whether forming an LLC makes sense for their business.
The changes in the U.S. tax code now require payment app providers, like PayPal or Square, to report payments for goods and services to the IRS if they total more than $600 per year. This is a big departure from the past when payment apps were only required to send the IRS a Form 1099-K for accounts with at least 200 business transactions a year if they totaled more than $20,000 in gross payments. This means that business owners who may not have had their income reported in the past from these payment providers may be subject to more scrutiny come tax time.
This change may affect your tax liability and, subsequently, your business’s bottom line—especially for the 7.5 million active sellers on Etsy, 4 million hosts on Airbnb, and countless other small business owners who use services such as PayPal, Venmo and Square to process customer payments.
The Time to Act is Now
The federal government gave small business owners nearly a year to figure out how the tax changes will impact their business. The new reporting requirement was signed into law in March 2021 and it went into effect on January 1, 2022. Don’t delay– waiting until tax season when you receive your 1099-K form will be too late for your 2022 fiscal year taxes.
It’s good to start thinking now about whether forming an LLC is right for your business. Here are five benefits of forming an LLC:
Credibility: Right or not, many established businesses view an entity as more established and credible than a sole proprietor. Some people choose to not do business with sole proprietorships due to legal, liability and long-term viability reasons. Formalizing your business can improve your reputation among customers, clients, vendors, partners, and investors.
Enable growth: A sole proprietorship is good for getting your business up and running, testing the waters, and determining whether you have a viable business. At a certain point, however, you may need to consider hiring, expanding, or taking on partners or investors—something that is much simpler and less risky for an LLC than a sole proprietorship.
Tax flexibility: Many people initially choose a sole proprietorship because it’s easy to file taxes. You tally up your income, subtract your expenses, and file a Schedule C with your personal tax return. But just because it’s easy, doesn’t mean it’s the better option. An LLC provides flexibility to choose pass-through taxes or corporate taxation—electing pass-through taxes eliminates the double taxation situation corporations face. As an LLC, you can elect to file separate business and personal returns like a corporation, or pass-through your business taxes to your personal return.
Simplicity: While an LLC requires annual fees, the cost and paperwork involved may be less burdensome than you expect. Also, a business services provider can make it even easier—allowing you to focus on your core business.
Protect your family’s personal assets: Starting and running a business can be scary. Forming an LLC helps protect you and your family from personal liability from the business. If an LLC is properly structured and the necessary formalities are observed, the owners shouldn’t have to worry about losing their home or other personal assets due to the LLC’s contractual obligations, debts, interruptions, or lawsuits—something that can happen when you operate as a sole proprietorship.
Seize the Opportunity
Just because you’ve operated as a sole proprietorship for years doesn’t mean you need to always operate as a sole proprietor. Switching to an LLC has various benefits, including making it easier to grow, building your credibility, increasing your tax flexibility and better separating your personal finances from your business. The recent tax changes that dictate who gets a 1099-K is a good opportunity to rethink what makes the most sense for you and your business.
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Erik Riegler has been involved with Rocket Lawyer as outside counsel since its formation in 2008 and as General Counsel since 2016. Erik has worked with technology companies in the San Francisco Bay Area since 1996, both in private practice (WSGR and Riegler Legal) and as General Counsel (LookSmart, THX and Rocket Lawyer).After graduating with his law degree, he started his career as a law clerk for Judge Stotler in U.S. District Court in southern California. Erik holds BA and JD degrees from U.C. Berkeley and an MS degree from the London School of Economics. He enjoys helping technology companies innovate, scale, and create value for customers. He also enjoys skiing, biking, hiking and spending time outdoors with his family.
LLC stock image by Zhanna Hapanovich/Shutterstock