No matter how temporary or permanent your situation, you’ll need to represent yourself as a business while you’re working out of your home. Why? Because if you earn four hundred dollars or more per year working in your profession (beyond wages you earn as an employee), you must pay taxes on that income as a self-employed individual. This requires you to form a business with you as its employee.
For tax purposes, there are three types of business structures you can choose. You can establish your business as a sole proprietorship, a partnership or a corporation.
Sole Proprietorship. As a sole proprietor, your business is you. You are responsible for any debts, legal obligations and liabilities, and you reap all of the profits from your business. No legal forms need to be drawn up when you form a sole proprietorship. You simply file a Schedule C "Profit or Loss from Business" at tax time along with your Form 1040. Your Social Security number is used as your business’s federal identification number. (In some instances a sole proprietor must also have an Employer Identification Number, or EIN.) This is the simplest structure and the one most often chosen by creative professionals when they’re starting their businesses.
Partnership. A partnership involves two or more people in a situation where all profits, losses, legal obligations and other business liabilities are shared by the partners. Each partner’s share is determined by a percentage of his interest in the business. The percentage is usually based on financial contribution, reputation and/or expertise. A lawyer (or lawyers–one representing each partner) must draw up a partnership agreement.
Corporation. A corporation has nothing to do with the number of people involved in the business. One person can form a corporation and be its sole employee. The difference from sole proprietorships and partnerships is that a corporation is considered separate from the individual who owns it. Forming a corporation will safeguard you from personal liability, meaning your personal assets won’t be affected if your corporation goes bankrupt.
When you incorporate, you become known as a C corporation, the first stage of incorporation. As a Subchapter C Corporation you’ll have to pay corporate taxes on all profits; the profits distributed to yourself and other stockholders in your corporation will also be subject to personal income taxes.
To incorporate, contact the corporate division of your secretary of state’s office to find out what your state’s procedures are for incorporating. Pick a name for your corporation; you must clear it through the corporate division before you can incorporate. In addition to filing paperwork, you’ll also need to acquire an EIN.
Once you’ve incorporated, you can elect to become a S corporation, in which you will be treated almost like a sole proprietor, avoiding double taxation. Your business profits are taxed once as personal income. It also offers many tax advantages.
Many creative professionals find the Subchapter S corporation offers an ideal combination of limited personal financial liability and single taxation. Although corporations qualify for tax breaks, these may be offset by the expenses involved in forming a corporation. Filing the papers to form a corporation requires a minimal financial investment of two hundred to three hundred dollars if you do it yourself. If you choose to have a lawyer file, the cost jumps to around a thousand dollars. Consider as well that you’ll pro-bably want the services of an accountant, and you’ll incur a charge for the initial consultation plus annual fees for the preparation and filing of corporate tax and/or personal returns.
You won’t want to pay an attorney to draw up your incorporation papers if you plan to make less than ten thousand dollars a year or if your situation is temporary or indefinite. Many creative professionals with successful businesses advise starting as a sole proprietor and growing into the idea of incorporating. You can always reevaluate your situation a few years down the road and decide to incorporate if your business growth warrants it.