When you decide to go out on your own, whether as a free-lancer working for others or to build your own customer or client base in your profession or industry, a sole proprietorship is often the best initial business structure. It doesn’t cost you anything to set up and all you need is a tax identification number, a business bank account and a business license.
However, once you’re established, you may want a more substantial business structure like an S corporation or a limited liability company (LLC). If you set it up and operate it correctly, an S corporation or an LLC can shield your personal assets from business lawsuits. An S corporation can also add a higher level of perceived credibility and stature with your customers and clients.
I typically recommend LLCs for holding rental real estate, not for an an operating business. The California Franchise Tax Board charges each entity a minimum $800 annual tax. But it imposes an additional fee on LLCs. The LLC fee on gross receipts over $250,000 is $900, over $500,000 is $2,500 and over $1,000,000 is $6,000. This is in addition to the $800 annual LLC tax, and it is based on gross receipts, not net profits. If your LLC brings in $250,000 and your net profit is $100,000, you have to pay a $900 LLC fee. Because of this extra LLC tax, we rarely recommend LLCs for small California businesses.
Another big advantage of an S corporation is that you may be able to distinguish your W2 earnings from shareholder distributions, and this could result in a significant savings in payroll taxes.