Need tax advice for a profitable hobby. Should I form an LLC?
March 5, 2010 8:11 AM Subscribe
I run a website that in recent years has started to generate a lot of income. I earned around $13,000 in 2009 with $9,000 in expenses (mostly server bills). Most of that 13k was taxed at 28% however, and my expenses were subject to the 2% rule. I was dinged with a nasty tax bill this year that I want to avoid next year. I'm wondering if forming a LLC makes sense from a tax perspective for me. I live in Maryland by the way.
Given my circumstances, I need to know whether I should get advice from an accountant or a tax lawyer. I'd rather not get both since I don't have much money to work with and I feel like most of the steps for forming an LLC/filing taxes I can do myself. I just need a professional's advice and opinion to make sure I'm not making any stupid mistakes.
That being said, I have a list of general questions. Maybe there are others I should ask?
- Will I pay less in taxes if I form an LLC? What tax rate would LLC income be subject to if it's less than $20,000?
- Do I have to worry about self employment taxes if I don't plan on paying myself with income from the LLC?
- I was planning on forming the LLC in Maryland. Is there any reason not to?
- How exactly do I transfer ownership of the website to the LLC? Is it just a matter of updating the whois information?
If anyone knows an answer to any of these questions that's great. Are there any others I should be asking?
Given my circumstances, I need to know whether I should get advice from an accountant or a tax lawyer. I'd rather not get both since I don't have much money to work with and I feel like most of the steps for forming an LLC/filing taxes I can do myself. I just need a professional's advice and opinion to make sure I'm not making any stupid mistakes.
That being said, I have a list of general questions. Maybe there are others I should ask?
- Will I pay less in taxes if I form an LLC? What tax rate would LLC income be subject to if it's less than $20,000?
- Do I have to worry about self employment taxes if I don't plan on paying myself with income from the LLC?
- I was planning on forming the LLC in Maryland. Is there any reason not to?
- How exactly do I transfer ownership of the website to the LLC? Is it just a matter of updating the whois information?
If anyone knows an answer to any of these questions that's great. Are there any others I should be asking?
I looked into this. The only real way to dodge the taxes seemed to be to set up an LLC and pay one's self in distributions (the idea being to avoid self employment tax) and it appeared to be more expensive to set up and audit-flag raising than it was worth, especially what with the upcoming tax increases on capital gains. Also in MA (dunno about Maryland) incorporating would have substantially increased state income tax rates because you have to pay at the corporate income tax rate.
You may however be able to set up a tax-deferred self-employment retirement account (like a SEP IRA) in order to tax defer some of your self-employment income, beyond what you contribute to your day job 401(k) for example.
PS You should look into cheaper hosting! Unless your business is really media intensive that seems like too much to pay for server fees.
PPS For seriously, you should talk to an accountant because like kindall says it kinda sounds like you are probably not doing your taxes right.
posted by phoenixy at 8:35 AM on March 5, 2010
You may however be able to set up a tax-deferred self-employment retirement account (like a SEP IRA) in order to tax defer some of your self-employment income, beyond what you contribute to your day job 401(k) for example.
PS You should look into cheaper hosting! Unless your business is really media intensive that seems like too much to pay for server fees.
PPS For seriously, you should talk to an accountant because like kindall says it kinda sounds like you are probably not doing your taxes right.
posted by phoenixy at 8:35 AM on March 5, 2010
PS I should clarify that an LLC is not necessarily always taxed at the corporate income tax rate; didn't want to give you that impression. But it is correct that there aren't usually tax advantages to setting up an LLC. The accountant I spoke with said that the only real reason to set one up would be to shelter yourself from liability claims (for example, if you were running a skydiving business instead of a website it might be a good idea).
posted by phoenixy at 8:54 AM on March 5, 2010
posted by phoenixy at 8:54 AM on March 5, 2010
An LLC shields you from liability -- that what the LL or "Limited Liabilty" part means. But that doesn't mean tax liability, it basically means that if your company gets sued and you lose, your personal assets are shielded from the settlement. A fine thing to do, but not really relevant to your current problem.
As Kindall said above, your website only made $4k in profit, and this is the amount you should be paying taxes on, whether you are an LLC or not. File an amended return that itemizes your business expenses accurately, and you will get a big fat refund check. Find an accountant to help you do that, and then ask them to set you up so that you only pay what you really owe going forward.
And congrats for building a successful site -- this is good problem to have, right?
posted by spilon at 9:05 AM on March 5, 2010
As Kindall said above, your website only made $4k in profit, and this is the amount you should be paying taxes on, whether you are an LLC or not. File an amended return that itemizes your business expenses accurately, and you will get a big fat refund check. Find an accountant to help you do that, and then ask them to set you up so that you only pay what you really owe going forward.
And congrats for building a successful site -- this is good problem to have, right?
posted by spilon at 9:05 AM on March 5, 2010
Most of that 13k was taxed at 28% however, and my expenses were subject to the 2% rule.
Could you explain what you mean by this sentence, and in particular what the "2% rule" is? The only Google results on that phrase are not applicable to your situation.
Generally I agree with kindall; you need to claim your website-related expenses as business expenses on your tax returns. Whether or not you use an LLC does not impact this analysis.
posted by rkent at 9:33 AM on March 5, 2010
Could you explain what you mean by this sentence, and in particular what the "2% rule" is? The only Google results on that phrase are not applicable to your situation.
Generally I agree with kindall; you need to claim your website-related expenses as business expenses on your tax returns. Whether or not you use an LLC does not impact this analysis.
posted by rkent at 9:33 AM on March 5, 2010
You can only deduct unreimbursed expenses that are above 2% of your adjusted gross income. IRS.
Since this is intended for employees, applying it in this cases seems wrong to me.
posted by smackfu at 9:44 AM on March 5, 2010
Since this is intended for employees, applying it in this cases seems wrong to me.
posted by smackfu at 9:44 AM on March 5, 2010
I don't think you need a tax lawyer, I think you need a good small-business accountant (preferably someone with some experience handling tech / web companies' finances), and you need to not only look forward to this year but also back at whatever you did last year with an eye towards seeing if you overpaid. I've never heard of someone running a web business not being able to deduct server bills — if that was the routine case, virtually nobody would be able to make money online.
posted by Kadin2048 at 9:58 AM on March 5, 2010 [1 favorite]
posted by Kadin2048 at 9:58 AM on March 5, 2010 [1 favorite]
While my site didn't generate as much as yours, I decided to look into this as well last year. Generally I've found that a lawyer will be more expensive than an accountant in these circumstances and you can most likely get away with just an accountant initially.
A good small biz accountant will be more than capable of telling you what form of entity you need (if indeed you need any) and what steps you need to form it. A lawyer can assist with the paperwork but the accountant might be able to as well depending on how complex an entity you need (my guess is "not very").
Depending on how complex a business you run (hard to say with the few details you've given), it may also make sense to find an accountant that offers bookkeeping services as well (or can refer you to a good bookkeeper). That could save you a TON of hassle and money if you deal with complex transactions.
I opted to form an LLC given that I was offering services through one of my websites (the others were affiliate sites) and needed the liability protection. I decided that it just made more sense to run everything through the LLC to consolidate and keep one set of books.
posted by Elminster24 at 10:13 AM on March 5, 2010
A good small biz accountant will be more than capable of telling you what form of entity you need (if indeed you need any) and what steps you need to form it. A lawyer can assist with the paperwork but the accountant might be able to as well depending on how complex an entity you need (my guess is "not very").
Depending on how complex a business you run (hard to say with the few details you've given), it may also make sense to find an accountant that offers bookkeeping services as well (or can refer you to a good bookkeeper). That could save you a TON of hassle and money if you deal with complex transactions.
I opted to form an LLC given that I was offering services through one of my websites (the others were affiliate sites) and needed the liability protection. I decided that it just made more sense to run everything through the LLC to consolidate and keep one set of books.
posted by Elminster24 at 10:13 AM on March 5, 2010
For the income from my web site, I pay 15.3% self-employment tax on my net, after deducting my expenses, not on my gross.
The IRS page on Deducting Business Expenses seems to say that you can deduct any amount of expenses, as long as they do not exceed your income from the business. (You can't deduct losses on your business from your income in another job.) I agree that you should talk to a small-business accountant.
posted by Ery at 10:52 AM on March 5, 2010
The IRS page on Deducting Business Expenses seems to say that you can deduct any amount of expenses, as long as they do not exceed your income from the business. (You can't deduct losses on your business from your income in another job.) I agree that you should talk to a small-business accountant.
posted by Ery at 10:52 AM on March 5, 2010
Forget the stuff about an LLC. An LLC has nothing to do with federal taxes because the IRS does not recognize the LLC as a special tax entity. LLCs are the creation of states not the feds. An LLC may provide some small amount of liability protection according to state law, but for most sole proprietor businesses it is just an unnecessary complication.
You should be funneling your business income through a sole proprietorship and file a Schedule C with your 1040. On the Schedule C you can deduct 100% of your business expenses. You will be subject to additional self-employment taxes on your business income unless the social security tax from your regular job is already a maximum. You will owe additional Medicare taxes regardless.
posted by JackFlash at 11:15 AM on March 5, 2010 [2 favorites]
You should be funneling your business income through a sole proprietorship and file a Schedule C with your 1040. On the Schedule C you can deduct 100% of your business expenses. You will be subject to additional self-employment taxes on your business income unless the social security tax from your regular job is already a maximum. You will owe additional Medicare taxes regardless.
posted by JackFlash at 11:15 AM on March 5, 2010 [2 favorites]
rkent: Could you explain what you mean by this sentence, and in particular what the "2% rule" is?
I suspect the OP is in the business of selling or exchanging collectibles such as coins, jewelry, comics, or stamps, and is therefore referring to the collectibles gain tax rate (box 2d on the 1099-DIV), which is 28%.
The "2% rule" refers to miscellaneous business expenses that can be claimed as itemized deductions. These are divided into two categories:
1) Expenses subject to the 2% limitation (e.g., meals and entertainment, travel expenses, tax preparation fees)
2) Expenses NOT subject to the 2% limitation (e.g., casualty losses from income property, gambling losses up to the amount of gambling winnings)
Expenses in category 1) are deductible only to the extent that they exceed 2% of the taxpayer's AGI; expenses in category 2) are fully deductible.
posted by velvet winter at 11:17 AM on March 5, 2010
I suspect the OP is in the business of selling or exchanging collectibles such as coins, jewelry, comics, or stamps, and is therefore referring to the collectibles gain tax rate (box 2d on the 1099-DIV), which is 28%.
The "2% rule" refers to miscellaneous business expenses that can be claimed as itemized deductions. These are divided into two categories:
1) Expenses subject to the 2% limitation (e.g., meals and entertainment, travel expenses, tax preparation fees)
2) Expenses NOT subject to the 2% limitation (e.g., casualty losses from income property, gambling losses up to the amount of gambling winnings)
Expenses in category 1) are deductible only to the extent that they exceed 2% of the taxpayer's AGI; expenses in category 2) are fully deductible.
posted by velvet winter at 11:17 AM on March 5, 2010
Assuming you are in the US, IANAA but the reference tot he 2% rule makes me think that you were treating them as business expenses of an employee, deductible on Schedule A. If you are self-employed, then you should be using a schedule C for your business. If you are not, then you really, really need an accountant. If you already filed for 2009, you (or your accountant) can amend the return and get a refund of any taxes that you overpaid.
There are bunch of different taxes to worry about self-employment income plus some expenses need to be depreciated rather than expensed plus whole quagmire of whether you want to try to deduct a home business office. Get help, at least until you feel confident that you fully understand what needs to be done.
posted by metahawk at 11:31 AM on March 5, 2010
There are bunch of different taxes to worry about self-employment income plus some expenses need to be depreciated rather than expensed plus whole quagmire of whether you want to try to deduct a home business office. Get help, at least until you feel confident that you fully understand what needs to be done.
posted by metahawk at 11:31 AM on March 5, 2010
I did the taxes for our small business for several years, but as we grew and the paperwork became more complex I became more uneasy about my abilities to handle it. We asked for referrals from our peers, and settled on a CPA. The first consultation was free, and I feel that he saved us so much money for that hour, it made me sick to think we waited so long. I honestly believe the fee he charges us now to do our taxes is a fraction of the money we save every year. Our only regret is that we waited so long to do it.
posted by raisingsand at 11:39 AM on March 5, 2010
posted by raisingsand at 11:39 AM on March 5, 2010
To clarify, I should add that I agree with everyone who has recommended dropping the LLC idea and filing a Schedule C to report your business income and expenses. And the 2% rule is only applicable to unreimbursed employee business expenses, as others have mentioned. If you are a sole proprietor filing a Schedule C with your 1040, and not an employee, the 2% rule will not be applicable.
As someone who is self-employed, you will also need to file Schedule SE and pay self-employment tax of 15.3% on your net earnings from self-employment ($4000 in your case, assuming your figures and calculations were correct). Half of this tax can be claimed as an adjustment to income on your 1040, Line 27.
Talk to a tax accountant. Your situation doesn't sound too complex overall, but it sounds as if you may have made some errors and overpaid, and may need to file an amended return.
posted by velvet winter at 12:05 PM on March 5, 2010
As someone who is self-employed, you will also need to file Schedule SE and pay self-employment tax of 15.3% on your net earnings from self-employment ($4000 in your case, assuming your figures and calculations were correct). Half of this tax can be claimed as an adjustment to income on your 1040, Line 27.
Talk to a tax accountant. Your situation doesn't sound too complex overall, but it sounds as if you may have made some errors and overpaid, and may need to file an amended return.
posted by velvet winter at 12:05 PM on March 5, 2010
Best answer: You don't need a tax lawyer. You just need a CPA or other tax professional. If you paid 28% on $13,000 you may have overpaid by $3000 or so. It is well worth getting a CPA to fix things up for you. It will probably cost less than $500.
If you have already filed your taxes, your CPA can help you file an amended return to get your overpayment back. This refund will be well worth paying for a CPA.
If you haven't filed yet you can try to find a CPA but it might be too late for the April 15 deadline since CPAs are working frantically with their existing customers and may not be able to schedule you for an appointment until after tax day. In this case, you can simply file for an extension using Form 4868. This is a very simple form and takes 5 minutes to fill out. It will allow you to wait until October 15 to file your return. You do have to pay your estimated tax now with the form. You will have to pay interest on the amount that you underpay. This delay will allow you plenty of time to find a CPA and get your taxes figured out. Filing an extension is very simple and very commonly done -- no big deal -- as long as you pay the estimate now.
If you have the CPA fill out your taxes once and see out how it is done, you may find that you can do it yourself next year using tax preparation software like TurboTax.
posted by JackFlash at 2:46 PM on March 5, 2010
If you have already filed your taxes, your CPA can help you file an amended return to get your overpayment back. This refund will be well worth paying for a CPA.
If you haven't filed yet you can try to find a CPA but it might be too late for the April 15 deadline since CPAs are working frantically with their existing customers and may not be able to schedule you for an appointment until after tax day. In this case, you can simply file for an extension using Form 4868. This is a very simple form and takes 5 minutes to fill out. It will allow you to wait until October 15 to file your return. You do have to pay your estimated tax now with the form. You will have to pay interest on the amount that you underpay. This delay will allow you plenty of time to find a CPA and get your taxes figured out. Filing an extension is very simple and very commonly done -- no big deal -- as long as you pay the estimate now.
If you have the CPA fill out your taxes once and see out how it is done, you may find that you can do it yourself next year using tax preparation software like TurboTax.
posted by JackFlash at 2:46 PM on March 5, 2010
Best answer: A decent guy on a neglected blog wrote a good guide on how to pick an accountant for your online business that may be helpful to you.
posted by RikiTikiTavi at 4:28 PM on March 5, 2010 [1 favorite]
posted by RikiTikiTavi at 4:28 PM on March 5, 2010 [1 favorite]
Response by poster: Thanks for the reality check, guys. I think it's clear to me that I need to talk to an accountant.
posted by rq at 6:23 PM on March 5, 2010
posted by rq at 6:23 PM on March 5, 2010
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Filing an LLC will not change your tax situation, because income from the LLC passes through to the owners, who pay personal income tax on it. The LLC is not taxed at all. See Wikipedia on LLCs.
But yes, see an accountant. Clearly he will save you much more than you will pay him.
posted by kindall at 8:32 AM on March 5, 2010