Is the thought of trying to make some extra cash constantly on your mind? Maybe you’ve got a day job, but you’re looking for something to supplement that income. Maybe it’s selling a product online, or real estate. Or maybe you want to start a business with the hope that someday you can leave your ‘day job’ to turn your passion into a career. Whatever it is, you might be wondering if you need a business entity, and if so, the question is which business entity makes sense – a Corporation, an LLC, or an S-corporation?
Typical Scenario
Just for context, let’s consider the typical entrepreneur. For them, owning their business is a full-time job, and in that situation, it would typically be wise to setup a business entity. An S-corp typically makes sense when their business generates annual net income greater than $40,000. But this isn’t your full-time job. This is merely your “side hustle”. You don’t need a business entity for your side hustle, let alone an S-corp, right? Or do you? Even though your business is merely a “side hustle”, you could still benefit from setting up a business entity. There are a few reasons for that.
3 Reasons to Have a Business Entity for Your Side Hustle
- If you’re concerned with liability, you should consider setting up a business entity, even if your business is just a side hustle. An LLC/Corp provides the corporate veil just the same to a part-time entrepreneur as it does to a full-timer.
- If you want to have a business name that you use for marketing, advertising, etc., setting up a business entity makes sense. The name of the business entity would typically be the name of your business.
- Setting up a business entity can help you feel more legitimate and take your ‘side hustle’ more seriously. Also, whether it’s justified or not, others may tend to treat your ‘side hustle’ as more legitimate. If that attracts more business, then it’s well worth it!
What about Taxes?
The only difference between you and the full-time entrepreneur is that you’re also working a day job with a W2. From a tax perspective, this is significant. This is because W2 folks have payroll taxes withheld on their wages. Payroll taxes are basically Social Security and Medicare contributions. In order to put everyone on the same page, entrepreneurs must also pay into Social Security and Medicare. They do that through self-employment taxes, which is typically 15.3% (12.4% for Social Security and 2.9% for Medicare). That’s on top of/in addition to income taxes.
The S-corporation can help with these taxes, whereby the entrepreneur claims part of their business income as a salary, and the rest of it is simply s-corp net income (which is not subject to payroll taxes or self-employment taxes). This is sometimes known as a ‘salary-dividend split’. There’s a whole reasonableness standard to the salary amount, and it’s a big topic. Mark Kohler has written a great article on this topic: “Dial in your S-Corp Strategy Before Year-End”.
When your business is simply a ‘side hustle’ and you’re working a day job, your entrepreneurial income is not hit with self-employment taxes as hard as the full-time entrepreneur who doesn’t have a W2 ‘day job’. This is because you are already contributing to Social Security and Medicare through your W2 wage. For example, if you’re making $150,000 in your W2, you’re already maxing out your annual Social Security contribution, so the self-employment taxes on your ‘side hustle’ income are only the Medicare portion (2.9%). As a result, you might not need an S-corp as soon as the full-time entrepreneur. But it all depends on how much you make in your W2 job, how much you’re making in your side hustle, etc. Remember, the S-corporation is primarily about self-employment taxes.
When it comes to income taxes, regardless of whether you have a business entity or not, (the IRS doesn’t care if you’re a sole prop, LLC, etc.) you’ll generally be able to deduct/write-off expenses related to your business. If you’re operating without a business entity, by default, you’re a sole proprietor (if it’s just you). As a result, you would report your business deductions (and income) on Schedule C of your 1040. However, keep in mind, an S-corporation tax return is less likely to be audited than a Schedule C, and for that reason alone, an S-corporation can still make sense.
To make a long story short, if you’ve got a side hustle, don’t automatically assume you don’t need a business entity simply because you’re not a full-time entrepreneur. The asset protection and tax savings could be a really need for you to succeed. Speak with your tax/business attorney and/or CPA to discuss what makes the most sense for your situation.