How The Right Business Formation Can Reduce Your Tax Bill

Early on in your business, you likely made little money as a sole proprietor. However, in an instant, your business could explode. And so can your tax bill.

This is what happened to one entrepreneur. A board game creator, he made less than $6,500 in revenue in a four-year period. Because his revenue was so low, he didn’t pay any taxes.

That changed in 2020 when COVID hit and people were staying home more. Board game sales exploded and the man’s business boomed. However, his business was registered as a sole proprietorship, so when he filed his 2020 taxes, he was hit with a bill for $7,000.

The man was in shock over the bill, but he learned his mistake. He formed an LLC for his business and treated his hobby more like a business. He added more products and expanded his distribution to online retailers Amazon and Walmart.com. In 2021, his company, Tabletop Monthly, made $500,000 in revenue while he kept his full-time job.

Why You Need an LLC

If you conduct business activity, such as by buying and selling products and services, but don’t formally register your business, the IRS will tax you accordingly. It will classify and tax your side income as sole proprietorship if you earn more than $400. This automatic classification means that sole proprietors make up nearly 87%  of non-employer companies in America.

The entrepreneur realized he needed an LLC in 2020, when his business exploded. He found an accountant, who told him that he needed to register an LLC and start using Quickbooks immediately.

The entrepreneur registered the business and his CPA told him that he needed to prepay taxes quarterly, so he had to make sure he had enough money to do so. He also opened separate business bank accounts for the LLC.

In the case of the entrepreneur, having an LLC protects the man’s personal assets. Plus, working with a professional ensures he follows proper intellectual property guidelines.

If you are serious about owning a business, you need to consider some type of legal entity formation besides a sole proprietorship. An LLC or a corporation would be a better choice, but having one of them is important if you want to protect yourself and your business. When it comes to taxes, having a legal entity structure can help you save money. That’s because the profits that come from sole proprietorships are subject to a 15.3% self-employment tax plus regular income tax. You end up overpaying in the long run.

Learn More About Sole Proprietorships

Sole proprietorships can be the ideal business formation for your company when you’re just starting out. However, as your business grows, a different formation like an LLC may be better by reducing your tax bill.

Starting a business? Seek legal help from Orlando sole proprietorship lawyer B.F. Godfrey from Godfrey Legal. We’ll help you make the right decisions to lead your business to success. Call (407) 890-0023 or fill out the online form to schedule a consultation with our office.

Source:

time.com/nextadvisor/financial-independence/board-game-llc-sole-proprietorship/