working for yourself, law and taxes for independent contractors freelancers and consultants 8th (2011)

Stephen Fishman, J.D.
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Working for
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Law & Taxes for
Independent Contractors,

Freelancers & Consultants
Stephen Fishman, J.D.
L A W f o r A L L
EIGHTH EDITION FEBRUARY 2011
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Cover Design SUSAN PUTNEY
Production MARGARET LIVINGSTON
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Printing DELTA PRINTING SOLUTIONS, INC.
Fishman, Stephen.
Working for yourself : law & taxes for independent contractors, freelancers & consultants / by Stephen
Fishman. 8th ed.
p. cm.
Includes index.
Summary: “O ers the strategies and information needed to become an independent contractor,
freelancer or consultant. It explains how to structure a business, negotiate contracts, ensure payments,
and understand and pay taxes.  e 8th edition includes the most current legal rules for contractors, as
well as up-to-date tax information” Provided by publisher.
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ISBN-10: 1-4133-1331-0 (pbk.)
ISBN-13: 978-1-4133-1357-4 (ebook)
ISBN-10: 1-4133-1357-4 (ebook)
1. Self-employed Legal status, laws, etc United States Popular works. 2. Self-employed United
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contractors Taxation United States Popular works. I. Title.
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2010038423
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Acknowledgments
Many thanks to:
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e many independent contractors throughout the country who permitted me to interview them.
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Table of Contents
Your Legal Companion for Working for Yourself 1
1

Working for Yourself: e Good, the Bad, and the Ugly 3
Working for Yourself: e Good 4
Working for Yourself: e Bad 6
Working for Yourself: e Ugly 7
How to Use is Book 8
2
Choosing the Legal Form for Your Business 9
Sole Proprietorships 10
Corporations 16
Partnerships 31
Limited Liability Companies (LLCs) 32
3
Choosing and Protecting Your Business Name 37
Choosing a Legal Name 38
Choosing a Trade Name 38
Choosing a Trademark 42
Choosing an Internet Domain Name 45
Conducting a Name Search 45
4
Home Alone or Outside Office? 47
Pros and Cons of Working at Home 48
Restrictions on Home-Based Businesses 51
Deducting Your Home Office Expenses 55
Pros and Cons of an Outside Office 63
Leasing a Workplace 63
Deducting Your Outside Office Expenses 65
5
Obtaining Licenses, Permits, and
Identification Numbers
69

Business Licenses 70
Employer Identification Numbers (EINs) 71
Sales Tax Permits 74
6
Insuring Your Business and Yourself 75
Health Insurance 77
Disability Insurance 85
Business Property Insurance 87
Liability Insurance 89
Car Insurance 91
Workers’ Compensation Insurance 91
Other Types of Insurance 94
Ways to Save on Insurance 94
7
Pricing Your Services and Getting Paid 97
Pricing Your Services 98
Getting Paid 104
8
Taxes and the Self-Employed 121
Tax Basics for the Self-Employed 122
IRS Audits 129
Ten Tips to Avoid an Audit 132
9
Reducing Your Income Taxes 135
Reporting Your Income 137
Income Tax Deduction Basics 139
Business Use of Your Home 149
Cost of Business Assets 149
Car Expenses 154
Travel Expenses 159

Entertainment and Meal Expenses 162
Health Insurance 163
Start-Up Costs 166
10
e Bane of Self-Employment Taxes 169
Who Must Pay 170
Self-Employment Tax Rates 170
Earnings Subject to SE Taxes 171
Computing SE Taxes 172
Paying and Reporting SE Taxes 172
Outside Employment 173
11
Paying Estimated Taxes 175
Who Must Pay Estimated Taxes 176
How Much You Must Pay 178
When to Pay 180
How to Pay 182
Paying the Wrong Amount 183
12
Rules for Salespeople, Drivers, and Clothing Producers 185
Statutory Employees 186
Statutory Independent Contractors 189
13
Taxes for Workers You Hire 191
Hiring People to Help You 192
Tax Concerns When Hiring Employees 193
Tax Concerns When Hiring Independent Contractors 200
14
Record Keeping and Accounting Made Easy 207
Simple Bookkeeping 208

How Long to Keep Records 219
If You Don’t Have Proper Tax Records 219
Accounting Methods 220
Tax Year 223
15
Safeguarding Your Self-Employed Status 225
Who Decides Your Work Status? 226
What Happens If the Government Reclassifies You? 226
Determining Worker Status 228
e IRS Approach to Worker Status 229
Tips for Preserving Your IC Status 234
16
Retirement Options for the Self-Employed 239
Reasons to Have a Retirement Plan (or Plans) 240
Individual Retirement Accounts (IRAs) 241
Employer IRAs 244
Keogh Plans 245
Solo 401(k) Plans 246
Roth 401(k) Plans 247
Retirement Plans If You Have Employees 248
17
Copyrights, Patents, and Trade Secrets 249
Intellectual Property 250
Copyright Ownership 251
Patent Ownership 258
Trade Secret Ownership 258
Using Nondisclosure Agreements 259
18
Using Written Client Agreements 267
Reasons to Use Written Agreements 268

Reviewing a Client’s Agreement 270
Creating Your Own Client Agreement 271
Putting Your Agreement Together 272
Changing the Agreement After It’s Signed 275
19
Drafting Your Own Client Agreement 277
Essential Provisions 278
Optional Provisions 288
Sample Client Agreement 296
Using Letter Agreements 296
20
Reviewing a Client’s Agreement 305
Make Sure the Agreement Is Consistent With the Client’s Promises 307
Make Sure the Contract Covers at Least the Basics 307
Provisions to Avoid 307
Provisions to Consider Adding 313
Client Purchase Orders 313
21
Help Beyond is Book 315
Help Resolving Disputes 316
Finding and Using a Lawyer 319
Help From Other Experts 320
Doing Your Own Legal Research 321
Appendixes
A
Forms and Documents
Asset Log
Expense Journal
Income Journal
Invoice

B
Sample Agreements
General Independent Contractor Agreement
Contract Amendment
Nondisclosure Agreement
Index

Your Legal Companion
for Working for Yourself
W
orking for yourself gives you free-
dom employees rarely get to experi-
ence in their professional careers.
Whether you label yourself “self-employed,”
an “independent contractor,” a “free lancer,” a
“consultant,” or even a “business owner,” you
have a unique opportunity to choose how you’ll
do business, where you’ll do business, and how
the operation will run.
Of course, with that freedom comes a lot of
responsibility, too. You’ll have to generate your
own work, choose and set up the right business
entity, follow legal and tax rules, and maybe
even manage employees. e good news is, this
book will help you do it.
is book is a guide to law and taxes for
people who either work for themselves or would
like to. It covers all the legal and tax basics self-
employed people need to know, including:
•thebenetsanddrawbacksofworkingfor

yourself
•thedierenttypesofbusinessentities,and
which one is right for you
•whethertoworkathomeorrentanoce
•howtoinsureyourbusiness
•howtopriceservices,writeclient
agreements, and get paid
•howtohandleyourtaxesanduseyourself-
employed status to reduce them, and
•howtomanageemployeesandrecord
keeping.
is book is intended only for those self-
employed people who provide personal
services, such as writers, consultants, artists,
photographers, lawyers, and doctors. If your
business involves selling goods (rather than
services) to the public, this book is not for
you. Instead, you should refer to Legal Guide
for Starting & Running a Small Business, by
Fred Steingold (Nolo).
As you will discover reading this book—if you
haven’t found out already—being self-employed
can be both a dream and a nightmare. ere
are a lot of rewards and a lot of risks. e goal
of this book is to help you navigate the risks
so that they do not detract from the rewards,
which we hope will be rich and plentiful.
●

1

C H A P T E R
Working for Yourself:
e Good, the Bad, and the Ugly
Working for Yourself: e Good 4
Independence 4
Higher Earnings 4
Tax Benefits 5
Working for Yourself: e Bad 6
No Job Security 6
No Free Benefits 6
No Unemployment Insurance 6
No Workers’ Compensation 6
No Free Office Space or Equipment 6
Few or No Labor Law Protections 6
Complete Business Responsibility 7
Others May Discriminate 7
Working for Yourself: e Ugly 7
Double Social Security Tax 7
Personal Liability for Debts 7
Deadbeat Clients 7
How to Use is Book 8
Starting Up Your Business 8
Ongoing Legal and Tax Issues 8
4 | WORKING FOR YOURSELF
W
orkingforyourselfcanbebothnan-
cially and spiritually satisfying. But the
lot of the self-employed is not always
an easy one. You have to make the often dicult
transition from having an employer take care of

the details to handling everything on your own.
For example, you won’t have a company payroll
department to withhold and pay your taxes for you.
Many self-employed people (including those
with plenty of clients) get into trouble because
they don’t run their operations in a businesslike
manner. Spending a few hours now to learn the
nuts and bolts of self-employment law and taxes
can save you countless headaches—not to mention
substantial time and money—later on. You don’t
have to start wearing a green visor and bow tie, but
you do need to learn a few rudiments of business
and tax law.
Before you delve into the details of the following
chapters, read this chapter for an overview of the
pros and cons of being self-employed as compared
to being an employee. It may help you make an
informed decision if you’re thinking about striking
outonyourown—orhelpconrmthatyoumade
the right decision if you’re already working for
yourself.
Working for Yourself:
e Good
Being self-employed can give you more freedom
and privacy than working for an employer. It can
alsoresultinsubstantialtaxbenets.
Independence
When you’re self-employed, you are your own
boss—with all the risks and rewards that entails.
Most self-employed people bask in the freedom

that comes from being in business for themselves.
ey would doubtless agree with the following
sentiment expressed by one self-employed person:
“I can choose how, when, and where to work, for
as much or as little time as I want. In short, I enjoy
working for myself.”
e self-employed are masters of their own
economic fates. e amount of money they make
is directly related to the quantity and quality of
their work, which is not necessarily the case for
employees. e self-employed don’t have to ask
theirbossesforaraise;theygooutandndmore
work.
Likewise, if you’re self-employed, you’re normally
not dependent upon a single company for your
livelihood,sothehiringorringdecisionsof
any one company won’t have the same impact on
you as on that company’s employees. One self-
employed person explains: “I was laid o six years
ago and chose to start my own company rather
than sign on for another ride on someone else’s
rollercoaster.It’sscaryatrst,butI’mnowno
longer at someone else’s mercy.”
Higher Earnings
You can often earn more when you’re self- employed
than as an employee for someone else’s business.
Forexample,anemployeeinapublicrelationsrm
decided to go out on her own when she learned
thatthermbilledhertimeouttoclientsat$125
perhourwhilepayingheronly$17perhour.She

nowcharges$75perhourandmakesafarbetter
living than she ever did as an employee.
According to the Wall Street Journal, self-
employed people who provide services are usually
paid at least 20% to 40% more per hour than
employees performing the same work. is is
because companies that hire self-employed workers
(referredtothroughoutthisbookas“hiringrms”)
don’t have to pay half of the self-employed worker’s
Social Security taxes, or pay for unemployment
compensation taxes, workers’ compensation
coverage,oremployeebenetslikehealthinsurance
and sick leave for workers who are not their
employees. Of course, how much you’re paid is
CHAPTER 1 | WORKING FOR YOURSELF: THE GOOD, THE BAD, AND THE UGLY | 5
a matter for negotiation between you and your
clients. Self-employed people whose skills are in
great demand may receive far more than employees
doing similar work.
Tax Benefits
Self-employmentalsoprovidesmanytaxbenets
that aren’t available to employees. For example,
no federal or state taxes are withheld from your
paychecks by an employer as they must be for
employees. Instead, the self-employed normally
pay their own estimated taxes directly to the IRS
four times a year. is means you can hold on to
your hard-earned money longer. It’s up to you to
decide how much estimated tax to pay (although
there are penalties if you underpay). e lack of

withholding combined with control over estimated
tax payments can result in improved cash ow for
the self-employed.
More important, you can take advantage of many
tax deductions that are limited or unavailable for
employees. When you’re self-employed, you can
deduct any necessary expenses related to your
business from your taxable income as long as they
are reasonable in amount and ordinarily incurred
by businesses of your type. is may include,
for example, oce expenses (including those for
home oces), travel expenses, entertainment and
meal expenses, equipment costs, and insurance
payments. ese are covered in greater detail in
Chapter 4.
In contrast to the numerous deductions available
to the self-employed, an employee’s work-related
deductions are severely limited. Some deductions
available to the self-employed may not be taken
by employees—for example, an employee may
not deduct the cost of commuting to and from
work, but a self-employed person traveling from
his or her oce to that of a client may ordinarily
deduct this expense. And, even those expenses that
are deductible for an employee may be deducted
only to the extent they add up to more than 2% of
the employee’s adjusted gross income. is means
that most of an employee’s expenses related to
employment cannot be deducted fully.
In addition, the self-employed can establish

retirement plans, such as SEP-IRAs and solo
401(k) plans, that have tax advantages. ese plans
also allow them to shelter a substantial amount of
their incomes until they retire.
Becauseofthesetaxbenets,theself-employed
often ultimately pay less in taxes than employees
who earn similar incomes.
Six ings You May Not Know
About the Self-Employed
1. ere are lots of them. 16% of all workers in the
United States are self-employed.
2. Rich people are more likely to work for
themselves. Self-employed people account for
two-thirds of all American millionaires.
3. Lots of them are older. More people become self-
employed at age 50 or above than in younger age
groups (16.4% versus 10.2%).
4. ey tend to be happier. Self-employed people
are more likely to be completely satisfied with
their jobs than are employees: 42% of self-
employed Americans are completely satisfied
with their jobs compared with just 31% of
employees who are equally satisfied.
5. ey work more hours. Nearly half of all self-
employed Americans (49%) work more than 44
hours in a typical workweek, compared to 39%
of American workers overall, 38% in government
and in private business, and 30% in nonprofit
organizations.
6. ey tend to be born in the U.S.A.

In the past,
immigrants were self-employed at greater rates
than native-born Americans. However, this is no
longer the case. By 1997, native-born Americans
had higher self-employment rates than
immigrants.
6 | WORKING FOR YOURSELF
Working for Yourself: e Bad
Despite its advantages, being self-employed is
no bed of roses. Here are some of the major
drawbacks.
No Job Security
As discussed above, one of the best things about
being self-employed is that you’re on your own. On
the other hand, this can be one of the worst things
about it too.
When you’re an employee, you must be paid as
long as you have your job, even if your employer’s
business is slow. is is not the case when you’re
self-employed. If you don’t have business, you don’t
make money. As one self- employed person says:
“If I fail, I don’t eat. I don’t have the comfort of
punching a time clock and knowing the check will
be there on payday.”
No Free Benefits
Although not always required by law, employers
often provide their employees with health insur-
ance, paid vacations, and paid sick leave. More
generous employers may also provide retirement
benets,bonuses,andevenemployeeprotsharing.

When you’re self-employed, you get no such
benets.Youmustpayforyourownhealth
insurance, often at higher rates than employers pay.
Time lost due to vacations and illness comes directly
out of your bottom line. And you must fund your
own retirement. If you don’t earn enough money to
purchaseorcreatethesebenetsforyourself,you
will have to forgo some or all of them.
No Unemployment Insurance
e self-employed also don’t have the safety net
provided by unemployment insurance. Because
hiringrms(companiesthathireself-employed
people) do not pay unemployment compensation
taxes for the self-employed, these people cannot
collectunemploymentbenetswhentheirworkfor
armends.
No Workers’ Compensation
Employers must generally provide workers’ compen-
sation coverage for their employees. Employees are
entitledtocollectworkers’compensationbenets
for injuries that occur on the job even if the injury
was their own fault.
Hiringrmsusuallydonotprovideworkers’
compensation coverage for the self-employed
people they hire. If a work-related injury is a self-
employed person’s fault, he or she has no recourse
againstthehiringrm.(SeeChapter6.)And
evenifit’sthehiringrm’sresponsibility,theself-
employed person will have to deal with the expense
and hassle of a lawsuit.

No Free Office Space or Equipment
Employers normally provide their employees
with an oce or space in which to work and the
equipment they need to do the job. is is not
usually the case when a company hires a self-
employed person, who must normally provide his
or her own workplace and equipment.
Few or No Labor Law Protections
A wide array of federal and state laws protect
employees from unfair exploitation by employers.
Among other things, these laws:
•imposeaminimumwage
•requiremanyemployeestobepaidtimeanda
half for overtime
•prohibitdiscriminationandharassment
•requireemployerstoprovidefamilyand
medical leave, leave for military service, or time
o to vote or serve on a jury, and
•protectemployeeswhowishtounionize.
Few such legal protections apply to the self-
employed.
CHAPTER 1 | WORKING FOR YOURSELF: THE GOOD, THE BAD, AND THE UGLY | 7
Complete Business Responsibility
When you’re self-employed, you must run your
own business. is means, for example, that you’ll
need to have at least a rudimentary record -keeping
system or hire someone to keep your records for
you.(SeeChapter14.)You’llalsolikelyhavetole
a far more complex tax return than you did when
you were an employee. (See Chapter 8.)

Others May Discriminate
Because you don’t have a guaranteed annual income
as employees do, insurers, lenders, and other
businesses may refuse to provide you with services
or may charge you more than employees for similar
services. It can be dicult, for example, for a self-
employed person to obtain disability insurance,
particularly one who works at home. Health
insurance may be easier to get, but the premium
payments could cost you an arm and a leg without
thebenetofanemployer’sgrouprate.
Also, it may be more dicult to buy a house
because lenders are often wary of self-employed
borrowers. To prove you can aord a loan, you’ll
likely have to provide a prospective lender with
copiesofyourrecenttaxreturnsandaprotand
loss statement for your business.
Working for Yourself: e Ugly
Unfortunately, the bad aspects of self-employment
discussed above do not end the litany of potential
woes. Being self-employed can, in some respects,
get downright ugly.
Double Social Security Tax
For many, the ugliest and most unfair thing about
being self-employed is that they must pay twice
as much Social Security and Medicare taxes as
employees. Employees pay a 7.65% tax on their
salaries, up to a salary amount capped by the Social
Securitytaxlimit($106,800in2010).Employers
pay a matching amount. In contrast, self-employed

people must pay the entire tax themselves—a
whopping 15.3% on their income up to the
amount capped by the Social Security tax limit.
is is in addition to federal and state income
taxes. In practice, the Social Security tax comes to
less than 15.3% because of certain deductions, but
it still takes a big bite out of what you earn from
self-employment. (See Chapter 10.)
Personal Liability for Debts
Employees are not liable for the debts incurred by
their employers. An employee may lose his or her
job if the employer’s business fails but will owe
nothing to the employer’s creditors.
is is not necessarily the case when you’re self-
employed. If you’re a sole proprietor or partner in
a partnership, you are personally liable for your
business debts. You could lose much of what you
own if your business fails. However, there are
ways to decrease your personal exposure, such as
obtaining insurance. (See Chapter 6.)
Deadbeat Clients
Ugliest of all, you could do lots of business and still
fail to earn a living. Many self-employed people
have great diculty getting their clients to pay
them on time or at all. When you’re self- employed,
you bear the risk of loss from deadbeat clients.
Neither the government nor anyone else is going to
help you collect on your clients’ unpaid bills.
Clients who pay late or don’t pay at all have
driven many self-employed people back to the

ranks of those working for the boss. However, there
are many strategies you can use to help alleviate
payment problems. (See Chapter 7.)
8 | WORKING FOR YOURSELF
How to Use is Book
is book will help you make what’s good about
self-employment even better, make the bad aspects
less daunting, and—hopefully—make the ugly
aspects a little more attractive.
Exactly which portions of the book you’ll need
to read depends on whether you’re already self-
employed or just starting out.
Starting Up Your Business
If you’re just starting out, there are a number of
tasks you’ll need to complete before or soon after
you start doing business. ese include:
•choosingthelegalformforyourbusiness(see
Chapter 2)
•choosinganameforyourbusiness(see
Chapter 3)
•decidingwheretosetupyouroce(see
Chapter 4)
•obtainingbusinesslicensesandpermits
and a federal taxpayer ID number (see
Chapter 5)
•obtaininginsuranceforyourbusinessand
yourself (see Chapter 6), and
•settingupatleastarudimentarybookkeeping
system (see Chapter 14).
You should read the chapters discussing these

tasksrst.
Ongoing Legal and Tax Issues
Once your business is up and running, there are a
number of ongoing legal and tax issues you may
have to tackle. ese include:
•decidinghowtopriceyourservicesandtaking
steps to ensure you get paid (see Chapter 7)
•understandingbasictaxrules(seeChapter8)
•payingestimatedtaxes(seeChapter11)
•keepingtrackofyourtax-deductiblebusiness
expenses (see Chapters 9 and 14)
•dealingwithtaxesforanyemployeesor
independent contractors you hire (see
Chapter 13)
•takingstepstoensurethattheIRSdoesn’t
view you as an employee if you’re audited (see
Chapter 15)
•decidinghowtofundyourretirement(see
Chapter 16)
•usingwrittenclientagreements(seeChapters
18, 19, and 20), and
•dealingwithownershipofthecopyrights,
patents, and trade secrets you create (see
Chapter 17).
You can read the appropriate chapters when a
problem arises or read them in advance to help you
avoid problems from the outset.
●
2
C H A P T E R

Choosing the Legal Form
for Your Business
Sole Proprietorships 10
Tax Concerns 10
Liability Concerns 13
Audit Concerns 14
Corporations 16
What Is a Corporation? 16
Your Employment Status 16
Audit Risks 17
Liability Concerns 18
Corporate Taxation Basics 20
Taxes for C Corporations 21
Taxes for S Corporations 24
Disadvantages of the Corporate Form 28
Forming a Corporation 29
Professional Corporations 30
Partnerships 31
Ownership 31
Personal Liability 31
Limited Partnerships 31
Registered Limited Liability Partnerships 32
Limited Liability Companies (LLCs) 32
LLC Owners 32
Tax Treatment 33
Liability Concerns 34
Pros and Cons of an LLC 35
Forming an LLC 36
10 | WORKING FOR YOURSELF
A

s a self-employed person, one of the most
important decisions you have to make is
what legal form your business will take.
ere are several alternatives—and the form you
choose will have a big impact on how you’re taxed,
whether you’ll be liable for your business’s debts,
and how the IRS and state auditors will treat you.
ere are four main business forms that we’ll
discuss in this chapter:
•soleproprietorship
•corporation
•partnership,and
•limitedliabilitycompany.
If you own your business alone, you need not
be concerned about partnerships; this business
form requires two or more owners. If, like most
self-employed workers, you’re running a one-
person business, your choice is between a sole
pro prietorship, corporation, or limited liability
company.
Don’t worry too much about making the wrong
decision.Yourinitialchoiceabouthowtoorganize
your business is not set in stone. You can always
switch to another legal form later. It’s common, for
example, for self-employed people to start out as
sole proprietors, then incorporate later when they
become better established and make substantial
income.
Sole Proprietorships
A sole proprietorship is a one-owner business.

It is by far the cheapest and easiest legal form
fororganizingyourbusiness.Youdon’thaveto
get permission from the government or pay any
fees to be a sole proprietor, except perhaps for a
ctitiousbusinessnamestatementorbusiness
license. (See Chapter 5.) You just start doing
business; if you don’t incorporate or have a partner,
you are automatically a sole proprietor. If you’re
already running a one-person business and haven’t
incorporated, you’re a sole proprietor.
e majority of self-employed people are sole
proprietors. Most sole proprietors run small opera-
tions, but a sole proprietor can hire em ployees
and other contractors, too. Indeed, some one-
owner businesses are large operations with many
employees.
Tax Concerns
When you’re a sole proprietor, you and your busi-
ness are one and the same for tax purposes. You
don’tpaytaxesorletaxreturnsseparatelyforyour
sole proprietorship. Instead, you must report the
income you earn or losses you incur on your own
personal tax return, IRS Form 1040. If you earn
aprot,youaddthemoneytoanyotherincome
you have—for example, interest income or your
spouse’sincomeifyou’remarriedandleajointtax
return. at becomes the total that is taxed. If you
incur a loss, you can use it to oset income from
other sources.
Although you are taxed on your total income

regardless of its source, the IRS also wants to know
abouttheprotabilityofyourbusiness.Toshow
whetheryouhaveaprotorlossfromyoursole
proprietorship,youmustleIRSScheduleC,
Prot or Loss From Business, with your tax return.
On this form you list all your business income and
deductible expenses. (See Chapter 9.) If you have
morethanonebusiness,youmustleaseparate
Schedule C for each.
Sole proprietors are not employees of their pro-
prietorships; they are business owners. eir busi-
nesses don’t pay payroll taxes on a sole proprietor’s
income or withhold income tax. However, sole
proprietors do have to pay self-employment taxes
—that is, Social Security and Medicare taxes—on
their net self-employment income. ese taxes
must be paid four times a year (along with income
taxes) in the form of estimated taxes. Chapters 10
and 11 cover this in more detail.
CHAPTER 2 | CHOOSING THE LEGAL FORM FOR YOUR BUSINESS | 11
Ways to Organize Your Business
Type of Organization Main Advantages Main Disadvantages
Sole Proprietorship • Simpleandinexpensivetocreateand
operate.
• Ownerreportsprotorlosson
personal tax return.
•Ownerpersonallyliableforbusiness
debts.
• Notaseparatelegalentity.
C Corporation • Clientshavelessriskfromgovernment

audits.
• Ownershavelimitedpersonalliability
for business debts.
• Ownerscandeductfringebenetsas
business expense.
• Ownerscansplitcorporateprot
among owners and corporation, for a
lower overall tax bill.
• Moreexpensivetocreateand
operate than sole proprietorship or
partnership.
• Doubletaxationthreatbecausethe
corporation is a separate taxable
entity.
• Nobenecialemploymenttax
treatment.
S Corporation • Clientshavelessriskfromgovernment
audits.
• Ownershavelimitedpersonalliability
for business debts.
• Ownerscansaveonemploymenttaxes
by taking distributions instead of salary.
• Moreexpensivetocreateand
operate than sole proprietorship or
partnership.
• Fringebenetsforshareholdersare
limited.
Partnership • Simpleandinexpensivetocreateand
operate.
• Ownersreportprotorlosson

personal tax returns.
• Ownerspersonallyliableforbusiness
debts.
• Twoormoreownersrequired.
• Nobenecialemploymenttax
treatment.
Limited Liability Company • Ownershavelimitedliabilityfor
business debts if they participate in
management.
• Protandlosscanbeallocated
differently than ownership interests.
• Moreexpensivetocreateand
operate than sole proprietorship or
partnership.
• Nobenecialemploymenttax
treatment.
Adapted from Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo).
Hiringrmsdon’twithholdanytaxesfroma
soleproprietor’scompensation,butanyrmthat
paysasoleproprietor$600ormoreinayearmust
leForm1099-MISCtoreportthepaymentto
the IRS.
ExAmPlE:
Annie operates a computer consulting business
as a sole proprietor. She must report all the
income she receives from her clients on her
individual tax return, IRS Form 1040, and
leScheduleC.Sheneednotleaseparate
tax return for her business. In one recent year,
sheearned$50,000fromconsultingandhad

$15,000inbusinessexpenses,leavinganet
businessincomeof$35,000.Shereportsher
grossprotsfromconsultingandherbusiness
expenses on Schedule C. She must add her
$35,000prottoanyotherincomeshehasand
report the total on her Form 1040. She must
pay both income and self-employment taxes on
thisprot.