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.
FAQs
You are not required to have an LLC or legal business entity in order to run your side business, so the timing is up to you. However, whether you're still in the planning phases or have been running your side hustle for some time, forming an LLC is typically a smart, cost-effective choice.
Should I start an LLC for a side hustle? ›
An LLC Can Protect Your Personal Assets From Liability
Most importantly, all of those areas are considered to be separate from you personally. This means if another business or individual has an issue with your side hustle, then any action they take will be against the LLC and not you and your personal assets.
Is my side hustle considered a business? ›
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.
Do I need a business account for a side hustle? ›
Over 58% of people that are self-employed use their personal account to run their business, and this number is even higher for those that generate a side income. There is no rule from HMRC that forces you to open a business bank account to manage your business.
How much income before LLC? ›
In the United States, including the state of New York, the decision to form a Limited Liability Company (LLC) is not based on the amount of money a business makes but rather on other factors such as liability protection, taxation considerations, and the desire for a formal legal structure.
What is the downside of starting LLC? ›
Disadvantages of creating an LLC
Cost: An LLC usually costs more to form and maintain than a sole proprietorship or general partnership. States charge an initial formation fee. Many states also impose ongoing fees, such as annual report and/or franchise tax fees. Check with your Secretary of State's office.
Should an LLC owner take a salary? ›
If your LLC is taxed according to the default rules the members cannot be considered as employees and cannot receive a salary. However, if you choose to have the LLC taxed as a corporation, the members who actively work for the LLC can be considered employees and can receive a salary.
How does the IRS know if you have a side hustle? ›
Payment apps and online marketplaces might issue a Form 1099-K, informing you and the IRS of how much money you got for selling things or providing a service. If you make a profit through these activities, it's considered taxable income.
Do you pay taxes on side hustles? ›
The IRS considers your side gig earnings as self-employed income. That means you're responsible for paying quarterly taxes, since taxes aren't taken out of your check.
Should I start an LLC if I don't have a business? ›
Starting an LLC may help a new business establish credibility more so than if the business is operated as a sole proprietorship. Taxes. LLCs typically do not pay taxes at the business entity level. Any business income or loss is passed-through to the owners and reported on personal income tax returns.
Most small business sole proprietors with no employees will not be required to apply for an EIN. However, as your business grows, if you decide that you want to form an LLC and make your business your full-time income, then you will want to get an EIN.
Should I register my side hustle? ›
Giving your business a legal structure doesn't need to be a hassle—and if you're earning money at a side hustle, registering your business may be the best way to protect yourself from legal judgments, tax liens, and other expensive headaches that can cut into your bottom line.
How do I turn my side hustle into a legit business? ›
Turn Your Side Hustle Into a Business
- #1. Adopt the right mindset. ...
- #2. Ensure your portfolio is strong. ...
- #3. Take steps to scale. ...
- #4. Seek financing. ...
- #5. Start actively marketing your side-hustle. ...
- #6. Focus on your customers. ...
- #7. Team up with the right partners. ...
- #8. Establish your business.
The primary benefit of turning your side hustle into an LLC is personal asset protection. If something were to go horribly wrong while pursuing what you thought was a weekend passion that brought in a few extra dollars, your personal assets could be at risk.
What if my LLC makes no money its first year? ›
It is required to file taxes for an LLC even with no income. This is because the Internal Revenue Service (IRS) treats LLCs as pass-through entities, which means that the LLC's income is passed through to its owners and reported on their individual tax returns.
Does LLC money count as income? ›
LLCs are considered “pass-through entities,” which means the LLC itself does not pay federal income taxes on business income. Instead, income “passes through” to individual members of the LLC, who pay federal income tax earned from the LLC via their own individual tax returns.
What is the best business structure for a side hustle? ›
While you can operate your side hustle as a sole proprietorship without turning it into a legal business entity, getting an LLC for your side business can provide added protection and credibility.
Can you have an LLC that doesn't make money? ›
There are many businesses who are LLCs from day one. Before they have a penny in revenue coming in. So those businesses aren't financially self-sufficient and it's totally okay for them to be an LLC. There are other businesses that will operate for a while and then transition into an LLC structure.
Should I create an LLC for my freelance business? ›
You don't need to form an LLC to work as a freelancer, but keep in mind that operating as a sole proprietorship or general partnership means you're personally liable should anything happen. An LLC can prevent this by separating your personal assets from your business assets.
