Side hustles come in many shapes and sizes. Your own personal and financial situation is likely to differ from that of other people, as well. There are a handful of types of business entities to choose from when starting or formalizing a side hustle, and the best one for you depends on these various factors.
This article goes over the main types of legal structures for small businesses and how to choose between them.
Your side hustle is a business
Though the terms “side hustle” and “side gig” sound more informal than “small business,” a side hustle of any type is technically a business. When you earn money outside of the context of being an employee, you’re in business for yourself.
Business entity generally refers to the structure used for business activity. Any activity performed for profit is business. Even if you’re just earning $50 here and there by taking surveys or doing an expert consult call every once in a while, you’re technically conducting business. As such, taking some time to consider whether you’re using the most appropriate legal structure is important.
The legal structure of a business is the way in which the law classifies your business, with the most common structures being sole proprietorship, limited liability, partnership, and corporation. Structure type can impact your personal liability, finances, taxes, and other factors.
There is nothing wrong with conducting business without formally organizing a business. This simply means that you’re a sole proprietor, by default (more on sole proprietorships below). However, depending on the nature of your business activities, you should take the time to consider whether a formal structure would be more suitable.
The different types of business entities
The sections below summarize each of the main legal structures for small businesses, as well as their advantages, their disadvantages, and some considerations for each.
The majority of physicians starting a side hustle will want to conduct business as either a sole proprietor or a limited liability company (LLC). There are a few main factors to consider when choosing between either of these and other entity types:
- Management structure
- Potential needs with regard to transferring all or part of the business’s ownership
- Business financing needs
- The need to potentially conduct business in more than one state
It’s important to note that businesses are registered through individual states. Different states have different laws surrounding business entities and, to some extent, differences in the entity types available.
For example, California differs from most other states in that it requires certain professionals – including doctors, dentists, psychologists, and other healthcare professionals – to use professional business entities such as a Professional LLC (PLLC) instead of a “regular” LLC if the business activity utilizes the owner’s professional license.
Though a business entity is recognized through a state, the federal government takes interest, primarily in the form of taxes. You can read about business taxation on the IRS website.
A sole proprietorship is the simplest type of business. It is managed by one owner, and there is no distinction between that owner and the business itself. This means that the owner reports all income generated from the business on his personal tax return. Additionally, the owner is personally responsible for any debt incurred by the business.
Sole proprietorships are attractive for a few reasons:
- They don’t require any extra paperwork such as filing business formation documents with the state
- They don’t require any extra fees or taxes, such as state business privilege taxes
- Doing your taxes is easy
Of note regarding that last bullet, there is a common misconception that you cannot deduct business expenses as a sole proprietor. This is not true. Changing from a sole proprietorship to an LLC won’t allow you to deduct more expenses.
The main reason that many business owners choose not to conduct business as a sole proprietor is liability. A sole proprietorship provides no liability protection.
So, which physicians should stick with sole proprietorships for their side hustles? This is usually a matter of money. Setting up a formal legal structure for your business generally increases the cost of doing business. If the legal and accounting costs of establishing and maintaining an LLC or other type of business entity would exceed your revenue or be a significant percentage of your total revenue, it’s likely not worth it.
Another reason you may want to remain a sole proprietor is if you have no formal business plan, no consistent revenue, and no long-term goals for your side hustle. A physician working as a freelance medical writer who intermittently takes short-term jobs won’t get much benefit from establishing a legal entity.
However, most physicians with a side hustle have the goal of growing it and the potential to generate a significant amount of income (as well as liability). For them, an LLC is usually the best way to go.
Limited Liability Company (LLC)
An LLC is a business structure that mixes elements of a sole proprietorship and a corporation. They are taxed similarly to sole proprietorships, meaning that the owner owes taxes on any profits generated by the business, rather than the business itself owing taxes. This makes paying taxes fairly simple.
The biggest difference – and benefit – when compared to a sole proprietorship is legal protection. The owner of an LLC is often not personally accountable for debts incurred by the LLC. Also, if the LLC is sued, the owner’s personal assets are often safeguarded. For LLCs with employees, the owner is not personally liable for actions of employees related to the business.
Having any legal structure other than a sole proprietorship, such as an LLC, makes it much easier to obtain funding for your business. Though many physicians bootstrap or self-fund their side hustles, this can be an important consideration for some business owners.
Along those same lines, having a formal business structure such as an LLC makes it easier to sell the business or transfer ownership down the road. As with funding, most physicians won’t end up doing this… but it’s good to have the option in case your side hustle really takes off.
Other benefits of an LLC are less tangible, but can be significant in the decision to use an LLC for a side hustle. One is credibility. Banks, vendors, and others you interact with in the context of your side hustle may take you more seriously if you run your business as an LLC rather than a side hustle. Customers may place more trust in you and your ability to provide the service they need.
Second, having a formal legal structure such as an LLC requires that you mentally consider your side hustle as a business. You’re more likely to put together a practical business plan, use good accounting practices, and use smart business strategies and management principles if you’re running an LLC instead of a sole proprietorship.
The disadvantages to forming an LLC are few, including modestly increased costs and administrative tasks.
A corporation is the original structure for providing business owners with personal liability protection. These are not simple to organize and run, and generally are not the best type of business entity for a side hustle.
The two main types of corporations are S Corps and C corps. Both have similar requirements as they relate to shareholder meetings, issuing stock, and adopting bylaws. The differences come in to play with taxes and ownership structure.
C Corps tend to be good choices for businesses seeking outside investors and that plan to grow and go public or get acquired.
S Corps, LLCs, and partnerships fall under the umbrella of what is known as pass-through entities. This means that the business profit “passes through” to the business owner, and the business owner pays taxes on the profit. With a business that is structured as a C Corp, on the other hand, the business itself pays taxes.
For small businesses, an S Corp usually makes more sense than a C Corp. S Corps come with the benefit of limited liability for shareholders, but are taxed as pass-through entities. There is no corporate income tax with an S Corp.
Of particular relevance to many physicians with a side hustle is that an LLC that is already formed and operating can choose to be taxed as an S-corp. This can result in significant tax savings due to the owner having a salary that is treated as a business expense.
Partnerships are owned by two or more people. If you’re going into business with someone else, you’ll need to consider which type of partnership is the best choice. However, since most physician side hustles are independent ventures, I won’t go into much detail here.
A general partnership is similar to a sole proprietorship with more than one owner and each partner sharing responsibility for profits, debts, and liabilities. It’s the simplest type of partnership and doesn’t require that a formal business be organized with the state. However, given the complexities and risks of going into business with a partner, even those starting general partnerships should consult with a lawyer to get their ducks in a row.
A limited partnership involves a general partner and at least one limited partner. The general partner typically controls the company’s day-to-day operations. Limited partners don’t control business operations or decisions, but do contribute financially. General partners are personally liable, while limited partners are not.
On the other hand, in a limited liability partnership (LLP), more than one owner is has limited personal liability. These can be well-suited from some professional groups, since one partner doesn’t want to be liable for another partner. The limitation of liability applies to certain situations, such as negligence claims or contractual obligations, but it doesn’t extend to others, such as fraud.
The best business entity type for your side hustle
Physicians and medical professionals are blessed with countless ways to earn money outside of their “regular” jobs. There are a lot of benefits to having a side hustle, including a source of money outside of your day job, an opportunity to learn, and a way to follow a passion while also providing a service or solution to others.
For the vast majority of physicians with side hustles, a sole proprietorship or an LLC is the most appropriate legal structure. There is nothing wrong with starting out as a sole proprietor and seeing where it takes you. You can always establish an LLC when you notice that your side hustle work is growing in revenue, consistency, or number of clients or customers.
If you’re side hustle grows to a point in which your LLC is generating a significant percentage of your total income, you may want to consider having your LLC taxed as an S-corp.
In any situation, it’s worth taking a broad look at your side hustles each year to see whether a change in structure may be beneficial.
Disclaimer: Please note that I am not a lawyer or an accountant. I’m just a doctor with a side hustle, sharing my thoughts. You should seek professional legal and tax advice before starting a business.