When does a side business become a “business,” and how do you need to structure it?
Note: You should consult a tax professional that can help you look at the pros and cons unique to your business and financial situation to ensure you have the best structure for your needs.
More and more people are turning interests and hobbies into lucrative side gigs—think dog sitting, tutoring, upcycling furniture, personal shopping, or selling things on Etsy. All of these essentially become your own small business and the money you receive counts as taxable income.
If your side hustle earns you more than $600 a year, you must report it on your taxes. That’s because the IRS considers you to be in business and earning income.
So, now that you’ve determined you have a business, do you need to formalize it or create a legal structure?
Types of Businesses
Sole Proprietorship
As soon as you start earning money in your side hustle, you’re a business and considered a “sole proprietor.” Simply, any individual who provides a service and collects money from it is a sole proprietor. Many businesses start this way and many don’t need to be anything else.
Limited Liability Corporation (LLC)
An LLC protects your personal assets from liability should something go wrong in your business. If you repair someone’s car improperly which causes an accident that causes damage, you could be liable for that damage. An LLC means someone can only go after the assets in your company—not your home or personal bank account.
An LLC also contains more formal operational agreements as to how the business is run. For side hustles that are generating
S Corp
An S corp is another form of legal business structure for business owners. They are corporations that pass corporate income, losses, and deductions through to their “shareholders” for tax purposes. A shareholder reports these income and losses on their personal tax returns to avoid double taxation on their taxable income.
With an S corp, you can be both the owner and an employee of your business, meaning you are entitled to a salary which is a business expense that your business can deduct—leaving you to pay taxes on a smaller profit, a tax benefit.
Most side hustles just don’t generate enough income to make an S corp an appropriate choice. An S corp has certain drawbacks for small business owners including additional fees for setup and maintenance as well as tax filing.
Keeping it Simple: Benefits of a Sole Proprietorship
For most side hustles, a sole proprietorship is the simplest structure, and if your side hustle doesn’t have significant liability risk, for many it’s the way to go.
Having a sole proprietorship for your business has advantages:
- It’s easy. You are by default a sole proprietorship as soon as you start doing business, no extra fees or paperwork necessary.
- You can deduct the cost of health insurance for you, your spouse, and dependents.
- You can deduct business expenses such as equipment, utilities, subscriptions, travel.
As your business grows or your liability increases, it’s time to re-evaluate and consider changing to an LLC. A tax professional can help you look at the pros and cons unique to your business and financial situation to ensure you have the best structure for your needs.
At Citizens Bank, we love nurturing small businesses—they’re the heart and soul of our community. From checking and savings accounts to loans that help you grow your business, we’re here to help you build your dream.