Overview for Sole Proprietors
Before we begin the forms, here is basic information about sole proprietorships and taxes.
What is a sole proprietorship?
A sole proprietorship is a business owned by one person. Sole proprietorships can have employees and operate in all the ways that a corporation or partnership can. The difference is that the financial and legal responsibility for everything rests with the owner. The owner has unlimited liability, which means that his/her personal assets can be used to pay for business debts.
Should my spouse be a co-owner?
Whether your spouse should be a co-owner is based on who will share the risk and rewards and whether your spouse is actively participating in the business. If you and your spouse agree to share risk and rewards for the business, you are forming a partnership. However, if your spouse is actively involved in the business, there are some tax benefits to treat your spouse as an employee rather than a partner. If your spouse is an employee, you can deduct health insurance premiums for your entire family as a business expense. The downside of this is that you have to do payroll paperwork for income paid to your spouse and you must provide the same health insurance benefits to your other employees so your benefits aren't "top heavy".
If you treat your spouse as a partner, you must determine your spouse's percentage contribution (it does not have to be equal). This does not guarantee that in case of a divorce, the courts will allocate business ownership on the same percentage, because the state looks at what is equitable. However, it does show your original intent for ownership.
If you are divorced and your spouse did not participate in the business or you formed sole proprietorship, the courts will divide the business according to what is equitable. Usually, the courts separate the inherent value of the business (goodwill) from the value of the business that is directly because of the person. Goodwill is often divided, while the direct value is not. This makes it important that spouses who are treated as employees receive a wage equal to their actual market value. Both you and your spouse should talk with an attorney about this issue so that you both are in agreement.
What if I want limited liability protection?
You can consider forming an LLC or a corporation. Both provide the same limited liability protection. In general, limited liability companies are more flexible than corporations because you do not have to have annual meetings with minutes. If you do not have outside employees, paying LLC owners involves significantly less government paperwork than corporations do. However, corporations are a bit easier to have outside investors who are not involved in the business. Both have roughly the same costs.
Limited liability protection will not protect you from actions that you took yourself or from tax obligations. You can purchase insurance for your actions (professional liability, errors and omissions).
Can I incorporate or form an LLC later?
Yes, but legally and for tax purposes, you will have to "close down" the sole proprietorship and "open" the new corporation or LLC. Your customers won't be affected, but you will have to go through the paperwork and accounting processes.
Revenue versus profit
Hopefully your business will have lots of sales...however, don't make the mistake of believing that your sales revenue is available for hefty personal salaries or business expansion. Payroll must be paid first. Then you will have to pay for your cost of goods and your operating overhead. A little less than 50% of the amount remaining must be paid in taxes (28% federal; 15.3% self-employment tax + 1-6.9% state taxes ). The remaining is available for your after-tax salary and business expansion.