Income, Taxes and Business Entities
I have a few questions in regards to income, taxes, and business entities. 1) I'm in the process of creating and selling products/services freelance. The money I would get from this venture I understand I have to pay the taxes on it. I want to separate this income from my personal finances. I would like to have my tax money on hand in the event I make enough income to tax. It's not my intent to spend the money on anything other than for more supplies or expenses for my creations. What is the best way to go about this? Should I open a checking account for the income and a savings account for the taxes? Should I open two checkings accounts? Or should I just open one? 2) Eventually down the line if this is something I want to do fully or take to the next level which business entity would be best for me to pursue? I'm am doing creative work/services. What would make more sense ? A LLC, C-corp, or S-corp? Ideally, I would like to keep the business separate from myself in the future so a sole proprietorship wouldn't be an option. Being that taxes seem to vary from location to location for additional info I am located in NY if relevant. Thank You Best and Many Thanks, Alisia Robinson
Answers:
I can tell you put some thought into your questions. First, congratulations on the freelance work.
To set aside money for taxes on any profit, you are right that it is a good idea to have a separate account for the taxes. Keep in mind that you need to be very careful to keep your business separate from your personal life. Therefore, you shouldn’t be paying business expenses out of a personal account or depositing business income directly into a personal account. That’s called commingling. If you commingle accounts and you ever got audited by the IRS, you’d have a nightmare on your hands because an IRS agent could subpoena ALL your bank accounts and assert that any deposits to ALL bank accounts (even personal accounts) is income, subject to tax. Then, the burden of proof would shift to you. Why go through all that torture? So do it the right way from the beginning.
Consider your freelance work a business, even if it’s conducted as merely a sole proprietorship without a dba (assumed name). Each business should have its own bank account, separate from any personal account and separate from the bank account for any other business you own. That is, each different type of business must be treated separately. To illustrate, if you had one business where you did consulting and a second business where you did dog grooming, each of those businesses should have its own bank account. Why? Because on your tax return, you’re required to separately report each activity/business. So you’d have personal accounts, at least 1 business account for each activity/business, and then yet another account to set aside money for taxes. I don’t think it matters whether that “tax” account was a checking or a savings account.
If you take the business to the next level, I would recommend an LLC in the beginning. An LLC will give you (as an individual) some legal liability protection, by separating the business from you personally. If the business got to a certain level of profitability, making an S election would be wise. A C corporation might also be a good option; it depends on your specific situation. I don’t counsel my clients to do a C corporation or S corporation on day one because those entities require you to file separate federal business tax returns, which means having to pay someone (like me) to do the tax returns. It doesn’t make sense to incur those additional compliance costs if you’re not making a profit.
You are right that taxes vary from location to location. That is, state and local taxes differ. Federal taxes are the same, regardless of where you live in the 50 states. Being in New York, you’re definitely subject to state income tax.
Feel free to contact me, if you wish to engage me for assistance.
Adam Dickreiter
I can tell you put some thought into your questions. First, congratulations on the freelance work.
To set aside money for taxes on any profit, you are right that it is a good idea to have a separate account for the taxes. Keep in mind that you need to be very careful to keep your business separate from your personal life. Therefore, you shouldn’t be paying business expenses out of a personal account or depositing business income directly into a personal account. That’s called commingling. If you commingle accounts and you ever got audited by the IRS, you’d have a nightmare on your hands because an IRS agent could subpoena ALL your bank accounts and assert that any deposits to ALL bank accounts (even personal accounts) is income, subject to tax. Then, the burden of proof would shift to you. Why go through all that torture? So do it the right way from the beginning.
Consider your freelance work a business, even if it’s conducted as merely a sole proprietorship without a dba (assumed name). Each business should have its own bank account, separate from any personal account and separate from the bank account for any other business you own. That is, each different type of business must be treated separately. To illustrate, if you had one business where you did consulting and a second business where you did dog grooming, each of those businesses should have its own bank account. Why? Because on your tax return, you’re required to separately report each activity/business. So you’d have personal accounts, at least 1 business account for each activity/business, and then yet another account to set aside money for taxes. I don’t think it matters whether that “tax” account was a checking or a savings account.
If you take the business to the next level, I would recommend an LLC in the beginning. An LLC will give you (as an individual) some legal liability protection, by separating the business from you personally. If the business got to a certain level of profitability, making an S election would be wise. A C corporation might also be a good option; it depends on your specific situation. I don’t counsel my clients to do a C corporation or S corporation on day one because those entities require you to file separate federal business tax returns, which means having to pay someone (like me) to do the tax returns. It doesn’t make sense to incur those additional compliance costs if you’re not making a profit.
You are right that taxes vary from location to location. That is, state and local taxes differ. Federal taxes are the same, regardless of where you live in the 50 states. Being in New York, you’re definitely subject to state income tax.
Feel free to contact me, if you wish to engage me for assistance.
Adam Dickreiter
