Structuring Your Next Side Hustle

Posted on: September 25, 2025 by Mike Munson, CFA in Tax Strategy

In recent months, I've noticed a significant uptick in clients starting side businesses—from pharmaceutical startups in South America to local farm stands selling eggs and honey. One of the earliest questions every entrepreneur faces is: What's the best way to structure my business for taxes and compliance?

If you have questions about your specific situation, please reach out to your primary advisor or your tax prep project manager so we can address your needs directly.

Today's Focus: Business Structure Selection

The answer to how you structure your business affects how much tax you'll pay, whether your personal assets are protected, and how you can pay yourself. No matter the size or industry, choosing the right structure from the start can save you thousands in taxes and protect your personal wealth.

This guide breaks down the most common business structures, when they make sense, and the key tax implications of each.

Key Takeaways

Start Simple – For most people, an LLC in your home state offers the best balance of protection and flexibility.
Grow Into Complexity – If your profits increase, consider electing S-corp status to save on self-employment tax.
Avoid Delaware – Unless you're seeking venture capital, forming in your home state is simpler and cheaper.
Understand Payroll Rules – S-corp and C-corp owners must run payroll. Sole proprietors and default LLCs do not.

Common Tax Structures (and When They Make Sense)

🏪 Sole Proprietorship

Example: You're a freelance graphic designer making $40,000 a year.

How it works: You report business income on your personal tax return. There's no separate business tax return.

✅ Pros:

Super simple and cheap to set up
No special filings required beyond your personal tax return

❌ Cons:

You're personally liable if something goes wrong
All profits are subject to self-employment taxes

📊 Tax Considerations:

No separate tax return; business income and expenses are reported on your personal tax return (Schedule C)
All profits are subject to self-employment taxes (roughly 15%)
Can contribute to a SEP IRA or Solo 401(k)
May qualify for the Qualified Business Income (QBI) deduction

🤝 Partnership

Example: Two friends start a catering business together, splitting profits 50/50.

How it works: The partnership files a separate informational return (Form 1065), but each partner reports their share of profits and losses on their personal return.

✅ Pros:

Easy way to start a business with someone else
Shared startup costs and responsibilities

❌ Cons:

Each partner is personally liable for the full amount of business debts
Disagreements between partners can derail the business

📊 Tax Considerations:

The partnership files a separate informational return (Form 1065), but profits flow through to each partner's personal tax return via Schedule K-1
Each partner pays self-employment tax on their share of the income
May qualify for the QBI deduction
Partners can contribute to retirement plans based on their share of income

🏢 LLC (Limited Liability Company)

Example: A yoga instructor making $80,000 a year forms an LLC to protect her personal assets.

How it works: Default tax treatment is like a sole proprietorship (if one owner) or partnership (if multiple owners). Single-member LLCs file no separate return; multi-member LLCs file Form 1065 like partnerships.

✅ Pros:

Protects personal assets
Flexible in terms of taxation and ownership structure
Simple to maintain in most states

❌ Cons:

Slightly more paperwork than a sole proprietorship
Some states charge ongoing LLC taxes or annual franchise fees

📊 Tax Considerations:

Taxed as a sole proprietorship (one owner) or partnership (multiple owners) unless you elect S-corp or C-corp taxation
Profits are subject to self-employment tax under default treatment
May qualify for the QBI deduction
Eligible to contribute to SEP IRA or Solo 401(k)
Electing S-corp status may reduce self-employment tax, but adds complexity

🏭 S-Corporation (can be LLC or C-corp taxed as an S-corp)

Example: A marketing consultant earns $200,000 through an LLC and elects S-corp taxation. She pays herself a $90,000 salary and takes the rest as profit distributions.

How it works: You pay yourself a salary (subject to payroll taxes); remaining profits are taken as distributions, which are not subject to self-employment tax.

✅ Pros:

Significant tax savings on self-employment tax once profits are substantial
Retains liability protection (if formed as LLC or corporation)

❌ Cons:

Requires running payroll
Separate tax return required
Subject to more formalities and additional costs
Lower retirement contribution limits than sole proprietors or partnerships

📊 Tax Considerations:

You must pay yourself a "reasonable salary," subject to payroll taxes (Social Security and Medicare)
Remaining profits may be taken as distributions, not subject to self-employment tax
Typically worth considering once profits exceed $250,000
Must file Form 1120-S annually
May qualify for the QBI deduction

🏢 C-Corporation

Example: A tech startup wants to raise money from investors and issue stock options.

How it works: The corporation pays taxes on its profits, and shareholders pay tax again on any dividends received.

✅ Pros:

Best for high-growth startups looking to raise venture capital
Can issue multiple classes of stock and offer equity to employees
Easier to scale and attract institutional investors

❌ Cons:

Double taxation on dividends (corporate level + shareholder level), though this can be avoided by paying salaries instead of dividends
More complex legal and compliance requirements
Separate tax return required
Lower retirement contribution limits than LLCs or sole proprietors

📊 Tax Considerations:

Pays a 21% federal corporate tax on profits
Dividends are taxed again at the individual shareholder level
Can be efficient if profits are reinvested in the business
May qualify for Qualified Small Business Stock (QSBS) Section 1202 gain exclusion if stock is held for 5 years and meets other requirements

Why Delaware Isn't Always the Best Choice

Delaware is famous in startup circles, but for most small businesses, it adds cost and complexity without real benefit.

⚠️ Key Points:

Extra Fees: If you run your coffee shop in California but incorporate in Delaware, you must register in both states—and pay fees in both
No Tax Savings: You'll still pay income tax where the business actually operates
Unnecessary Legal Infrastructure: The Delaware Court of Chancery is great for large corporations with shareholder lawsuits—not a local bakery or design studio

Rule of Thumb: Unless you're raising venture capital, form your business in your home state.

Do You Need to Run Payroll?

This is a common source of confusion for new entrepreneurs.

Structure	Payroll Required?	How You Get Paid
Sole Proprietors & Partnerships	No	Owner draws; report income on personal return
LLCs (default status)	No	Same as above—no payroll unless you elect S-corp treatment
S-Corps	Yes	Must pay yourself a reasonable salary
C-Corps	Yes	If you're working in the business, you must be on payroll

💡 Example:

Photographer with an LLC earning $50,000 → takes owner draws, no payroll needed.

Same photographer with S-corp status earning $150,000 → might pay a $70,000 salary via payroll and take the remaining $80,000 as distributions.

Bottom Line

Choosing the right structure can feel like a big decision, but you don't need to make it alone. We'll walk through your goals, risk tolerance, and tax situation to find the structure that fits both your short-term needs and long-term growth.

The key is to start simple and grow into complexity as your business evolves. Most successful entrepreneurs begin with an LLC in their home state and consider S-corp election once their profits justify the additional compliance costs.

Over the next few months, we'll publish additional tax strategy notes related to other key business planning topics, so stay tuned for further guidance.

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