Smart Money Podcast – Success in Self-Employment: How to Choose a Business Structure to Navigate Liability and Taxes (S Corps, C Corps, LLCs, Sole Proprietorships)

Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions. In this episode:

Learn how to choose the right business structure for financial success and legal protection as a self-employed entrepreneur with answers to common questions.

How do you select the right business structure when you’re self-employed?

What are the financial implications of different business structures on personal finances?

Hosts Sean Pyles and Elizabeth Ayoola help you understand how to navigate your business’s legal identity by comparing business structures for self-employment. They begin with a discussion of different business structures available for self-employment, with tips and tricks on separating personal liability from business, the ease of filing taxes as a pass-through entity, and the importance of obtaining an EIN for building business credit.

Then, Elizabeth talks to Bryan Jackson, certified financial planner and senior wealth advisor at Beacon Pointe Advisors, about the nuances of LLCs, S corporations, and traditional corporations. They discuss the pros and cons of each structure, the flexibility of LLCs in terms of membership and taxation and the more stringent requirements of S corps.

How do you navigate the complex process of business formation?

What should you consider when transitioning from self-employment to business ownership?

Bryan talks through the critical questions that shape your enterprise’s future, offering guidance on the implications of single versus multiple ownership, the relevance of non-U.S. partners and the significance of share transferability. He also delves into topics such as the distinction between being self-employed and a business owner, the benefits of formalizing a business early, and the different financial impacts of each business structure on personal finances.

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This transcript was generated from podcast audio by an AI tool.

S corps, C corps, LLCs, sole proprietorships, there’s a plateful of word salad awaiting you if you decide you want to work for yourself. And choosing how to run your solo business is one of the many forks in the road of self-employment.

These are basically business structures that allow you to separate yourself from your business, i.e. your business is essentially its own entity, and you are an operating member or a partner or owner or shareholder in that business.

Welcome to NerdWallet’s Smart Money Podcast. I’m Sean Pyles.

And I’m Elizabeth Ayoola.

Today we bring you the fourth and final episode of our Nerdy deep dive into self-employment. Elizabeth, everything we’ve been talking about throughout this series makes me think, “Hey, I could work for myself,” but then I do think I would probably miss the Nerds.

Life as a nerd keeps me on my toes, so I feel you.

Well, one primary question for folks who think they may want to leave “the man” and set up shop for themselves is how to structure their business. Should you be a limited liability corporation, a sole proprietorship, an S corp? And how do you even make that calculation? And a reminder that in this series we’re only really talking about how to set up an individual business, not a small business where you’re hiring people and need payroll and insurance and all that good stuff. This is just if you want to work for yourself, as a gig worker, freelancer, contractor, solo entrepreneur, etc. But there are different ways to set up an individual business, and it’s not always as simple as you would think.

Definitely not. And honestly, it just really depends on the business that you’re doing. So let’s say that you’re just freelancing. You got a few projects here and there, then you probably don’t need an LLC. And then again, maybe you do, or maybe you have a fast growing side business that’s helping you accumulate a funky tax bill. In that case, you may want to set up an S corp. I’m inserting myself here, which is what I did. And an S corp is a subchapter, S corporation under the IRS regulations, and there’s so much to consider. So we’re going to walk you through all the options and hopefully by the end of this episode, you’ll have the information you need to figure out what’s best for you.

Yeah. And this is really a key decision, isn’t it? In our previous episodes, this is the one question you have to ask yourself before figuring out how to manage your taxes and save for retirement. Those are somewhat determined by what kind of company you designate yourself as. The benefits you give yourself rely on the various rules for what company you establish.

So it’s really important to understand these various business structures and hopefully we’re going to help you do that today so you can get started on your new business. If you’re uber ambitious or you’ve been putting it off, maybe you’ll even start tomorrow.

All right. Well, we want to hear what you think too, listeners. To share your ideas and questions around self-employment with us, leave us a voicemail or text the Nerd hotline at 901-730-6373. That’s 901-730-NERD. Or email a voice memo to [email protected]. So Elizabeth, where do we start today?

Well, our guest today is Bryan Jackson. He’s a certified financial planner and a senior wealth advisor at Beacon Pointe Advisors. Bryan is also a program director at Southern Methodist University and he’s a board member at the National Business Association.

All right. Well, we are back in a moment with Elizabeth’s interview. Stay with us.

Welcome to Smart Money, Bryan. Thank you so much for agreeing to come and chat with me today.

Absolutely. Thank you for having me, Elizabeth.

So can you take us through the different business structures that are out there and the pros and the cons of each?

Absolutely. So when you talk about a business structure, typically what you’re talking about is how the business is set up and recognized by the IRS. When you’re going to start a business, you have a decision to make as to how you’re going to be structured and recognized, and each of those different structures carries a set of pros, cons, limitations, etc. So I’ll start with probably the most simple, and that is what’s called a sole proprietorship. And a sole proprietorship is essentially you’re going into business and you’re going to basically be yourself. Everything runs through you personally, and it’s obviously the most simple structure, it’s the easiest to get going, but there’s downsides to that and that is there’s no separation between you and your business, meaning that you’re exposed to as much liability as your business is exposed to, as well as any debts that you take on as the business owner. They’re your personal debts.

So the sole proprietorship is very common for people that want to just get going, but there are also some other entities that you can move forward with as well. And that would be a what’s called a limited liability corporation or LLC or a S corporation or a traditional corporation. Essentially, as you move through these others, you are beginning to separate yourself from your business in terms of responsibility for debt that the business takes on as well as liability exposure.

Can you also quickly give me an example of the kind of job or rather business that you might have or self-employment work you might have that might make you just want to go for sole proprietorship?

Sure. I mean really anything, but specifically if it’s just going to be you and you’re going to own the business 100% and you’re not going to have any partners. So let’s say you’re very good with construction and you want to start a business as a general contractor or you want to start your own roofing business or drywall business or consulting business, those are things that you can start as a full proprietor. I actually started off myself as a sole proprietor. I was an insurance broker. I was working in corporate America, decided that I wanted to be my own boss and start my own business.

So I basically just went and got an insurance license and began operating as a sole proprietor. I didn’t have any employees and I was selling insurance to other business owners. And it worked. I operated that business by myself for myself. And it wasn’t until my banker said, “You may want to look at doing something a little different,” that I started looking at the other entities that were available to me. I was able to open up a business bank account in the name of myself, basically what they call a DBA account or a doing business as account, and it was a sole proprietorship account. Generally speaking, if you’re going to be the sole owner of the business, just about any business can start as a sole proprietorship.

Thank you so much for explaining that. So now I’m going to double back and take it back a little bit to you breaking down each of the business structures. So can you just briefly, as you did with the sole proprietorship, explain to me what an LLC and an S corp and a traditional corp is.

These are basically business structures that allow you to separate yourself from your business, i.e your business is essentially its own entity and you are an operating member or a partner or owner or shareholder in that business. The advantage to that is that you’re separating your liability from the liability of the business. And as you become more established, that becomes more and more important. We’re in a very litigious society, and generally speaking, you don’t want to have your personal assets and the things that you’ve worked hard for exposed to the risks of your business.

The LLC is probably the most flexible form of business structure available in the marketplace right now. And it essentially allows you to separate your liabilities and your exposures from your business. But it also makes it very simple from a tax standpoint because it’s a pass through entity. And basically what that means is when you go to file the taxes for yourself or for your business, your business and its profit and losses passes through to you personally as the member of the LLC essentially. That’s a good thing. Okay. Because with the corporation, you have to file a separate tax return for the corporation that you do for yourself personally.

So there’s a few more hoops to jump through with the corporation, but you don’t have to be a big multinational multi-billion dollar operation to be a corporation. You can be a corporation with one person. You can be a corporation with two people. You can be an LLC with one person. You can be an LLC with multiple owners. So all of these have the ability to allow multiple layers of ownership. That’s very important.

Would you say that one of the primary differences between an LLC and the corporations is the amount of paperwork that you’re doing, especially when it comes to tax filing?

Absolutely. The LLC, your business has income, it has revenue, it has expenses, and obviously if your revenue and income are greater than your expenses, then you’re going to have a profit in the business. And let’s say that profit in the business is $100,000 at the end of the year. Well, that $100,000 flows through to you as an individual and you’ll show $100,000 in taxable income on your personal tax return. Very, very simple.

Whereas with a corporation, the corporation has its own tax return and the corporation is going to pay you generally as the owner, some form of a salary and it’ll deduct as an expense the salary that it pays you. The end of the year, there’ll be a certain amount of earnings. And what happens with those earnings can take a distribution as an owner and the corporation can write that off. I mean, it’s much more complex. So it’s much more simple to have an LLC if you’re looking to separate yourself from the personal liability and the debts associated with the business than it is to do so with a corporation.

Got you. And then what would you say is, just in quick terms, what are the main differences between an LLC and an S corp?

LLCs can have an unlimited number of members. S corp can have no more than 100 shareholders. Non US citizens and residents can be members of LLCs. S corps cannot have non US citizens and residents as shareholders. S corporations can not be owned by corporations. LLCs can. It’s a little bit more restrictive than the LLC. Those are the big differences as well as the ongoing formalities. What are some of the required formalities of S corporations, including adopting some bylaws, issuing stock, holding initial and annual director shareholder meetings, keeping minutes with corporate records. With LLCs, it’s really you adopt your operating agreement, you issue your membership shares and you can hold and document an annual member meeting, but it’s not as formal as the S corporation.

So I do want to ask what are some questions people can ask themselves, maybe just a couple of guiding questions to know which business structure is best for them?

So I would say the number one question would be, is this going to be a business owned by just you or are you starting a business with other people? Because if it’s going to be just, you can really utilize any of these structures, but if you’re going to have partners, you’re going to need to look at either LLC, S corp or corporation. Other questions would be, am I going to have any non US partners? Do you want to issue freely transferable shares or is that not important to you? The membership shares of the LLC, the other members have to approve transferability of those.

I do have another question though, because listeners that we are trying to speak to in this episode are people who aren’t necessarily trying to have tons of other people in the business or hire people. So mostly people who are just maybe doing project based things or just basically not complicated, pretty simple. So for these kinds of people, what are some things that we should think about when choosing a business structure?

Yeah. Well, I would definitely think about separating yourself from liability of your business. And I would also think about the ease of filing your taxes. Those are the two big things that I looked at when I was looking at what structure was going to make sense for me. I wanted flexibility. I knew it was just going to be me. So I decided, look, I think an LLC gives me everything that I need. It gives me the separation, it gives me that corporate veil of protection that I feel like I need as my business starts to grow. But it also gives me the simplicity of being a pass through entity where the profits and losses of the business passed through to me. So I set up an LLC, it works out well. Now as an LLC with just one member, you’re automatically considered what’s called a disregarded entity in the eyes of the Internal Revenue Service. And when you set up a single member LLC, the IRS automatically says you’re a disregarded entity. And basically all that means is you are taxed the same as a sole proprietorship.

All right. So I’m going to jump into the next question, which is about how you set up your business. I know the first time that I faced with the task of setting up a business, I was completely intimidated. It’s interesting because during the time on social media I saw lots of people saying, “Hey, we’ll set up your LLC for X amount.” But luckily I decided to try to do it myself and I realized it wasn’t as difficult as I thought it would be. But that’s just me personally. It may be difficult for other people. So can you just walk us through the steps of how you set up an LLC just briefly?

I can talk about my experience. I mean essentially, there’s a number of companies online and you want to find a reputable one with a good track record that will essentially help you set up your business online and become either incorporated or register as a sole prop. I had to come up with the name of the business. I had to establish where the business was going to be located. They filed my articles of incorporation with the state that I was doing business in. I called the IRS and got the EIN number or an employer identification number that would be associated with my business, essentially my business’s tax ID or my business’s social security number. And what I started doing at that point was using that EIN number to open up specific business accounts in the name of my LLC.

So I opened up an LLC business bank account, and then I wanted to start building my business’ credit separate from my own credit, so that I could take out debt for the business in the name of the business. But you can start getting business credit cards, you can start getting business lines of credit and start establishing your business credit profile, which is generally going to be important or it was important for me when I started looking at getting SBA loans and things of that nature.

All right. So I have a couple more questions for you. Just quickly I also wanted to ask, I feel like sometimes self-employed and business owner are used interchangeably. So is there a main difference between the two or is it just more or less the same thing?

If you’re self-employed even as a sole proprietor, that sole proprietorship is your business. If you consider yourself self-employed, you own a business. It may not be an incorporated business, but it’s a business.

At what point is it beneficial to set up a business formally in one of the structures that we just described versus just doing your stuff on the side?

Yeah. I don’t think there’s any downside to doing it right away, personally. What’s the downside? That’s the question you have to ask yourself. What’s the downside of me getting an EIN number? It takes five minutes from the IRS. What’s the downside of me opening up a business bank account and keeping it separate from my personal checking and savings account? There’s no downside to incorporating and getting registered with your state. I mean, just get it done. I would just say put some thought into what structure you’re going to use off the bat. Just put some thought into that up front. But to answer your question directly, I would do it right away.

And then just to be clear, it’s been a while since I did it, but if you decide to just go the sole proprietor route, you don’t need to register or do you need to register to become a sole proprietor?

If you don’t do anything in terms of registration, your state or anything like that or go through any type of incorporation process, you’re going to be considered a sole proprietor.

Got you. And the only time that it’ll come up is during taxes when you report any side income that you made?

All right. What implications do each of these options that you mentioned in terms of the business structures have on your finances as it relates to taxes and also investing? This can get really detailed because there are different business structures and different implications, but are there any overarching themes that you can point out?

Like I was mentioning before, the S corp, the LLC, those are pass through entities. So from a taxation standpoint, they’re pretty simple in terms of tax preparation and definitely the sole prop is very straightforward in terms of tax preparation. And in terms of investing, I don’t see there being a ton of implications there. I know with certain deferred compensation plans or certain executive compensation plans, they like for them to be C corporations. Generally speaking, in terms of investing, I can’t think of a lot of implications on one versus the other.

So I guess I’ll double back to the question I asked before. Is there anything else that you would like to share and let people know before they go and start getting busy opening up a business account if that’s the right move for them, or registering a business rather?

Like I said earlier, you want to think about the entity that’s going to make the most sense for you early on. You’re not locked into it forever. You can change it, but put some thought into that. Going in, I think it’s wise to separate your business and personal liability and give yourself that corporate veil. That’s something you can do for $400 or $500 in an online service. I wouldn’t hesitate to do that at all. I think it’s really wise being someone that’s gone through that. I wouldn’t wait until you’re full-time in the business. If you’re still working in a W-2 role and you’ve got a business on the side, there’s absolutely nothing wrong with starting to get your structure set up right away, even though you’re not full-time in the business, it’s just going to save you some time.

And any tips for people who want to DIY incorporating their business or try to do it yourself?

It’s absolutely doable. It’s not difficult at all. Do not be intimidated by it. I did it DIY, my businesses, they’re still going today. I’m still filing tax returns on them today. And this has been over 15, 20 years ago when I knew a fraction of what I know now and it worked. So it makes sense. And yeah, nothing wrong with it at all.

And since we’re at the top of the year, my final question for you is for anybody out there who’s like, “Yep. This is going to become my year of becoming self-employed,” do you have any final advice for them?

Yes, do it. What are you waiting for? Having a business, owning a business, deciding to start a business is one of the greatest decisions that I’ve made in my lifetime. There’s some big ones out there. Who you marry, what career are you going to pursue and do I want to be my own boss? And we live in a country that celebrates small business ownership, that supports small business ownership, it is the lifeblood of this country. It’s not the massive corporations that you hear about and see about on television. It is small business. It is an amazing, amazing experience. You’re going to work harder than you ever have, but you’ll be more fulfilled than you’ve ever been in any corporate career. And it’s because it’s yours and you’re going to work harder for something that you own than you are more than likely for something that someone else owns. So if you’re thinking about it, there’s a reason. There’s a reason that it’s on your heart, listen to that and take the plunge. Will it be easy? Probably not. Will it be worth it? Absolutely.

Thank you for sharing that. It makes me want to take my stuff to the next level. But Bryan Jackson, thank you so much.

Thank you, Elizabeth. I appreciate the opportunity.

Well, Elizabeth, one thing that I’m going to be thinking about for a while to come is the phrase corporate veil of protection that Bryan used. Because for a lot of people who are debating the different ways to set up their business, that’s really what it’s all about. You want to protect yourself from our fellow citizens’ more litigious impulses, and protect your money from a tax standpoint. So at the end of the day, the decision is about what makes the most sense for you, the people you might be going into business with and your goals for the business.

Those are some good takeaways, Sean. I feel like for me, I didn’t realize each business structure just represented a different tax code and also that a main other difference is the level of liability that you have. That said, if I ever do decide to hire people, tried it before, probably going to do it again, this is good information to know. Bryan also gave me a good reminder about the importance of reading the fine print and how key that is to protect yourself when you’re doing business.

Well, Elizabeth, it’s hard to believe, but we are already at the end of our series about managing your finances as a self-employed worker. And I’ve got to say, when we began this journey, my attitude was largely, “I am far too lazy for this. I’m going to stick with my W-2 9 to 5 gig that I have.” But now you’ve got me thinking otherwise, especially as I worked to get my CFP designation and consider branching out into financial planning, your conversations over the past four episodes have made the idea of starting a business of my own feel much more doable. So thank you.

You are so welcome. And join us, Sean, on this side of the pond. It’s not always fun, but sometimes it’s profitable. We live in beautiful chaos on this side of the world. I can’t believe the series is over. It has really solidified my appreciation for self-employment, and it’s also given me tools I can use to ensure that I’m more profitable and growing my money moving forward. In some ways, I would say I even feel like I’ve been able to create a framework for myself by listening to the gems that the four different professionals shared. I really, really do hope though that listeners feel the same or at least have learned enough to move forward in an empowered way.

For now, that’s all we have for this episode. If you have a money question of your own, turn to the Nerds and call or text us your questions at 901-730-6373. That’s 901-730-NERD. You can also email us at [email protected]. Visit nerdwallet.com/podcast for more info on this episode. And remember to follow, rate and review us wherever you’re getting this podcast.

This episode was produced by Tess Vigeland. Sean helped with editing. Courtney Neidel helped with the fact checking. Sara Brink mixed our audio. And a big, big thank you to NerdWallet’s editors for all their help.

And here’s our brief disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.