Which business entity is appropriate?

[asukam55]

My husband runs cultural music classes as a small business in the community in the state of California. As of today, he is running the business as a freelancer, and he puts at least 30% of taxes aside every month from the profit. This is the first year for the business making enough profit and the total taxes reached over $1,000. 

1) Do you recommend for him to register as a solo proprietor to continue to run this school?

2) Is there any other type of business entity we should choose other than solo proprietorship to run this business? (small business, music school).

3) Our understanding is that he needs to pay quarterly taxes as his total tax is more than $1,000 today. How do we calculate quarterly taxes?

4) The business is still unstable, and there are some months the business expenses exceed the total net profit of the month. In this case, the tax becomes $0? Is it okay to have several months of the business expenses exceeding the total profit of the month?

Thank you for your time and knowledge!

[MarthaT]

Hello and thank you for your questions.

1.  A solo proprietor is anyone that performed services or sells products for profit that are not registered with the state.  As a freelancer you are considered sole proprietorship and you are subject to self-employment taxes.  

2.  You have the following business types you might consider. 

      - Limited Liability Company - Single member - You register your LLC to the state.  You file form 1040 Schedule C.  You have the benefit of Limited liability in case of any legal purposes.  You are separate from the LLC and you are not personally liable for any debts or obligations from the LLC.  As an owner you need to pay estimated taxes of at leaset 90% of the tax liability to the IRS every quarter and it includes self-employment taxes.   Your Self-Employment Tax is 15.3%(12.4% SS + 2.9% Medicare) of your net income.https://turbotax.intuit.com/tax-tips/small-business-taxes/limited-liability-company-taxes/L5TDDlstC

      - S-Corp is a corporation that is separate and distinct from its owners.  The shareholders have limited liability, including employees.  S-corp elect to pass corporate income, losses, deductions, and credits through to the shareholders for federal tax purposes.  Meaning the individual would report it through form 1120-S Schedule K1.  You make the election through form 2553.

      - You can find more information regarding different business entities at Business Structures -  https://www.irs.gov/businesses/small-businesses-self-employed/business-structures

3.  Yes, if he made more than $1,000.00 of net income he needs to pay self-employment taxes, which would be 15.3%(12.4% SS + 2.9% Medicare) besides the federal income tax that depends on your total taxable income.  You can use the Tax Calculator at https://turbotax.intuit.com/tax-tools/.

4.  It is alright if your business have losses or even zero net income in some months that is how most business operate.  Some months are good and some months are bad.  As long as you keep a good bookkeeping records because it will show at the end of the year how profitable or not you were.

I hope this answered your questions.  Thank you and have a wonderful day

[JBedford]

Hi, @asukam55 , thanks for the questions!

1) One does not "register" as a sole proprietor other than by filing a tax return with self-employment income. It is the "default". 

2) We are not allowed to advise on business entities, as it is outside of our scope. Sole proprietorship is certainly the simplest. If you are considering other entities, then I would advise you to consult with a local tax accountant or attorney who advises on such matters. 

3) The bare minimum you should pay in quarterly estimated tax payments is 100% of your 2022 tax liability from Line 24 of your Form 1040. If you make over $75,000 as a single filer, or $150,000 if married filing jointly, in self-employment income, then you should pay 110% of that number. You would pay this in four quarterly payments of 25% (or 27.5%) each. This will allow you to avoid an underpayment penalty. Also, don't forget to count any other tax payments you make. For example, if you have tax withheld from a job. This will reduce the amount you need to pay. 

4) If expenses exceed income, then there is no taxable income. This is quite normal for a new business. One only needs to be concerned with the "hobby rules" if one operates at a loss for several years in a row. 

Hope this helps, please let me know if not!