Choosing your entity
| Entity | Best for | Tax notes |
|---|---|---|
| Sole proprietorship | Testing an idea, freelancers starting out | Simplest; profits taxed on Schedule C; no liability shield |
| LLC | Most small businesses | Liability protection; taxed as sole prop/partnership by default — no tax magic by itself |
| S-corporation | Consistent profits roughly $60–80k+ | Pay yourself a reasonable salary (payroll taxes apply), take the rest as distributions free of Social Security/Medicare tax — often saves $5k–15k+/yr. Costs: payroll filings, separate return, more admin. |
| C-corporation | Venture-scale startups | Double taxation; rarely right for small service businesses |
Solo 401(k) vs SEP IRA vs SIMPLE
Self-employed retirement accounts crush employee limits because you're both employer and employee:
| Solo 401(k) | SEP IRA | SIMPLE IRA | |
|---|---|---|---|
| 2026 limit | Up to $72,000 ($24,500 employee + 25% of compensation employer; +$8,000 catch-up 50+) | Up to $72,000 (25% of compensation) | $17,000 (+$4,000 catch-up) |
| Best when | No full-time employees; want max savings and a Roth option; may need loans | Have employees (must cover them equally); want dead-simple admin | Small business with employees; simpler than 401(k) |
| Roth option? | Yes (employee portion) | No | Yes (if plan allows) |
| Catch | Form 5500-EZ once assets exceed $250k | Contributions are employer-only; can't do a Roth | Lower limits; early-withdrawal penalty 25% in first 2 years |
Deadlines: Solo 401(k) must be established by Dec 31 (contributions can go until tax filing); SEP IRAs can be opened and funded by the filing deadline including extensions.
Taxes: quarterly estimates & the QBI deduction
- Self-employment tax: 15.3% on net earnings (12.4% Social Security up to $184,500 + 2.9% Medicare, plus 0.9% over $200k) — on top of income tax. This surprises every new freelancer exactly once.
- Quarterly estimated taxes due January, April, June, September. Safe harbor: pay 100% of last year's total tax (110% if AGI was over $150k) and skip penalties. Automate 25–30% of every payment received into a separate tax savings account.
- QBI deduction (Section 199A): up to 20% of qualified business income deductible for pass-through owners — a massive, often-missed break. Phases out for high-income service businesses (SSTBs); your CPA should model it.
- Don't-miss deductions: home office (simplified: $5/sq ft up to 300 sq ft), health insurance premiums (above-the-line), HSA, business mileage ($0.70/mile for 2026 — track with an app), retirement contributions, business insurance, professional development.
- Hire the CPA before you need one. A good CPA pays for themselves in year one for any business over ~$50k profit. Interview two; ask how many clients like you they serve.
Separating business & personal
- Separate accounts, day one: business checking + business credit card. Commingling pierces your liability shield and makes bookkeeping hell.
- Pay yourself on a schedule: monthly owner's draw or salary — not random raids on the business account.
- Profit-first buckets: every deposit splits automatically — e.g., 30% tax hold, 10% profit, 50% operating, 10% owner's pay. Adjust percentages to your margins.
- Bookkeeping: QuickBooks/Wave/Xero from the first dollar. Reconcile monthly; it takes 30 minutes and saves 30 hours at tax time.
- Emergency funds ×2: 3–6 months personal and 2–3 months business operating expenses. Revenue is lumpy; buffers make it smooth.
Insurance & protection
- General liability + professional liability (E&O): often required by clients; cheap for most professions.
- Business overhead expense disability: pays rent/payroll if you're disabled — your personal disability policy doesn't.
- Key person & buy-sell funding: life insurance funding a buy-sell agreement means a partner's death doesn't become a war with their heirs.
- Umbrella: yes, business owners especially — see Insurance.
- Contracts for everything: scope, payment terms, kill fees, IP ownership. A $500 attorney review beats a $50,000 dispute.
Succession & buy-sell
If you have partners: a written buy-sell agreement funded by life/disability insurance answers "what happens if one of us dies, becomes disabled, or wants out" before emotions run high. Solo owners: document processes, name a successor operator, and make sure your estate plan addresses the business — your family inheriting a company they can't run helps no one.
FAQs
LLC or S-corp — which saves more tax?
An LLC by itself saves zero tax vs a sole proprietorship — it's a legal shield, not a tax election. The savings come from electing S-corp taxation: distributions escape the 15.3% self-employment tax. Worth it around $60–80k+ consistent profit, after subtracting payroll/admin costs (~$2–4k/yr).
How much should I set aside for taxes?
25–30% of net profit is the safe default (covers income + SE tax in most brackets). High earners in high-tax states: 35%. Park it in a separate high-yield savings account the day money arrives — "I'll figure it out in April" is how tax debt starts.
Can I have a Solo 401(k) and a day-job 401(k)?
Yes — but the $24,500 employee limit is shared across all 401(k)s. The employer/profit-sharing portion is per-business, so side income can still shelter a lot. This is a great setup for maxing total contributions.
Should I hire employees or contractors?
Misclassifying employees as contractors is one of the IRS's favorite audit targets — penalties are severe. The test is behavioral/financial control, not what you call them or what they prefer. When in doubt, get a CPA/attorney opinion; the DOL and IRS both publish guidance.