You'd only pay taxes if your revenue were more than your deductible payroll expenses (which as you say, you estimate to be 20% of your salary, which in an s-corp must be a "reasonable salary" for work performed).

There's no case where this law causes you pay tax on zero revenue. The problems require some revenue before they affect you, which might actually be another argument against it - you're disincentivized to create revenue from your early product if it's not going to be enough to cover your tax obligations.

The absolute worst case scenario would be having to pay taxes as if your revenue was nearly all profit - as if you had no expenses (or very few). As always, you only pay taxes on 'net income' - revenue minus expenses - this whole mess comes about by tweaking how expenses are calculated.

And that will be the case for me next year, so yes, this matters to me.

It is literally backbreaking for a friend who is self funding a team of engineers. The money to pay taxes literally doesnt exist. It was paid as salary.

I told him to ignore the accountants and simply not pay. Let the IRS come after him

But there's a very critical misunderstanding happening in a lot of comments here -the IRS taxes profit (net income), not revenue. Anyone with zero revenue is safe. Anyone with SOME revenue will potentially owe some taxes, and potentially in a very surprising (and unfair, I think) way. The basic example in the submission is quite correct.

>>>I told him to ignore the accountants and simply not pay. Let the IRS come after him.

This is a great way to end up both out of business AND in jail. It is not the smart play.

Not in this case, which is the challenge and pain. You can have a company with negative profit, and have to pay income taxes on revenue.

>This is a great way to end up both out of business AND in jail. It is not the smart play.

Strongly disagree, and this is how I run my business. There is sufficient ambiguity and debate on the topic to support an ambiguous reading. Nobody is going to jail. Worst case scenario you get a nastygram from the IRS in a year or two, provided the issue hasn't been clarified in YOUR favor.

If your company is living hand to mouth with expenses above revenue, the money the IRS wants literally doesnt exit.

Incorrect; you can have a company with negative cash flow and have to pay income taxes on profit - as the IRS defines it. And you can certainly disagree and argue with them about it, but they're likely to win.

>>>If your company is living hand to mouth with expenses above revenue, the money the IRS wants literally doesn't exit.

"I don't have the money I legally owe you because I spent it" is not a claim the IRS is going to care deeply about.

Here's the same situation, for not software. I buy a big fancy truck for my trucking business. It's 100k, capital asset, needs to be amortized over 10 years. I make $100k in revenue that year. No other expenses. What do I need to pay tax on in year 1? The $90k in net income that I have. I can't say to the IRS "but I spent all my cash on the truck" - they'll say "tough, pay us".

edit: as an aside - the above is why businesses usually like to lease or finance - the cash flow matches better.

Obviously, the question is then which one makes more sense for software development.

And either way it's very painful to change the rules entirely in a single tax year, especially for small businesses. FAANG companies will weather this either way, but it could kill small software businesses.

One alternative if it must be treated as a capital asset is to allow accelerated/immediate depreciation for small firms and individuals.

I can see the point that for large firms like with diversified R&D portfolios, development, on average, results in creation of capital assets.

For small firms, it is absolutely unclear that the product has any durable value at all.

Hyperbole. IRS doesn’t lift a finger for amounts such as these. They will send a letter of what they think you owe and offer a payment plan if you don’t have it immediately.

How would IRS get “their” money with you in jail? They’d also have to provide you with room and board.

If money went from the LLC into a "wage," it changed "hands." The IRS wants in on that.

If work went from the owner into an LLC, no money changed hands, and the IRS doesn't care.

But the very fact that people do S Corps shows that there is different tax treatment though.

The benefits of S and C corps don’t really come into play with single member LLC

For the short term (contracting) I'm simply working as a Sole Proprietor, but I don't really have much work or significant income yet.

If I may make one suggestion: even if you want to be a sole proprietor, look into getting an LLC.

If you run into trouble with a client, a properly-done LLC can save your house or other large assets.

With a sole proprietorship, all of your personal stuff can be on the hook too.

It's essentially the same advice as keeping separate devices for work and for personal use.

LLCs also generally aren’t useful for protecting you from creditors, because any lender will require you to give a personal guarantee.

If you are really worried about protecting your assets, you can purchase liability insurance.

> As a software developer you’re unlikely to be sued over anything that can’t be classified as personal negligence or malpractice.

Unlikely doesn't mean never. And a client's definition of negligence might also be malicious.

It is difficult for a company to successfully show that your LLC was at fault for some large dollar amount of damages, but that you the sole decision maker running that LLC, weren’t at fault through negligence or malpractice.

My point is not that you shouldn’t bother to protect yourself if you are worried about the risk, but that insurance, not an LLC is the best way to do it. By all means start an LLC too if you want.

The common advice of that every tiny business setup an LLC because it will save your house is wrong because it is only applicable to very specific circumstances that don’t apply to most sole proprietors. It’s also dangerous because most people that take this advice take it face value. Then they go online, start an LLC, and believe they are protected from all personal liability related to their business. When in fact they are protected from a very small fraction of likely potential liability.

An LLC can protect your personal assets from enforcement of contractual obligations. Say for example you agree to indemnify your client against patent infringement, and then through no fault of your own some of your code coincidentally happens to violate someone’s patent (and the patent holder finds out and successfully sues or settles with your client).

But don’t sign contracts like that in the first place. And it’s a good idea for contracts to have a clause allowing both parties to terminate the contract and to not make promises in your contract you can’t guarantee.

A single-member LLC and a single-member S-Corp are taxed largely the same on the revenues of their entity, in the sense that they're both essentially flow-through entities for a solo entrepreneur. From a tax perspective, an S-Corp is better than an LLC for 99% of solo entrepreneurs because if you have enough revenue, you can take some of it as qualified dividend which is taxed at a lower rate than directly passed-through income.

So if I went the S Corp route, I'd actually have to pay taxes on 0 revenue.

This is false. The income tax on $0 revenue (meaning no revenue, not no profits) is the same: $0. (Note, however, that many states have "fees" assessed on business entities like S-Corps and LLCs, even single-member LLCs, and in such cases a minimum fee is owed regardless of revenue.)

But as a regular LLC, my own work (as the owner) does not count as anything taxable, so I'm safe.

This is also false. The work you provide to the entity as an owner is still an R&D expenditure. The difference is that with the S-Corp, the expenditure cost is clearly documented, while with the LLC you're pretending that the number is $0 and gambling on not getting audited. This only matters once you start generating revenue...

Either way, not all of your salary would be subject to capitalization. If you have revenue, you clearly spent at least some time and work on marketing and business development, and expenses for those non-R&D activities are not capitalized.

On a further note, with the S-Corp, your salary offsets up to [your salary assigned to non-R&D tasks less 1/5 of your salary assigned to R&D] in revenue each year, and after an appropriate amount of salary (generally the SSI contribution threshold for the year) the rest of that annual revenue can be repatriated to yourself as a dividend at lower tax rates. With the LLC form, since you aren't paying yourself a salary, you owe tax on 100% of the revenue arising from the software you develop without any deductions. And it gets entirely taxed as regular income. Worse, it's self-employment income, meaning that in any realistic situation, you're paying a higher effective tax rate with the solo LLC form.

TLDR: If you actually care about tax, S-Corps are almost always the better option, and they're still the better option here.

So if the IRS audits me, they'll say that my work is worth something and therefore, I have to pay taxes on it?

Sounds awful.

But I and the accountants I talked to don't think that's the case.

Also, I'm not going to take R&D credits, nor claim deductions from salary, so why would they care?

And I did the math: yes, an S Corp is technically better. But at the revenue levels I plan on seeing, the difference isn't that much (a few thousand), and any revenue gets taxed right away, which is more convenient for me. I'll take that instead of complicating my taxes.

Well, no...since you're not claiming to be making any revenue from that work, it doesn't matter. Whether you deduct 100% or 20% of your salary from $0 business income you still have $0 of taxable business income (and as an individual you don't get NOL carryovers so that amount is lost to you forever).

In fact, in the event of an audit, you'd likely get a refund since the IRS would determine that you're incorrectly calculating your tax liability by failing to capitalize your R&D expenditure (i.e., your flow-through revenue which is entirely treated as self-employment income). But, because this error affects other years' returns, which means that a one-return audit can turn into a multi-return audit. It also means you get put on a very special list of taxpayers subject to increased scrutiny (meaning, significantly more likely to be audited again in a future year).

But at the revenue levels I plan on seeing, the difference isn't that much (a few thousand), and any revenue gets taxed right away, which is more convenient for me. I'll take that instead of complicating my taxes.

Yes, the LLC is much simpler when it's a disregarded (single-owner flow-through) entity. But it's more complicated once you add other members or any employees. And as you've pointed out, you're already paying more in taxes.

My issue isn't with you choosing to use the LLC form because it's simpler, my issue is with you claiming that it's better for tax purposes on a numerical basis when it is clearly not.

The problem is, as this whole comment section shows, is that is it not clear.

Because it isn't, I decided to go with the simpler option because I don't plan on having employees.

There is no dispute amongst tax advisors about whether a single-owner S-Corp is better than a single-member LLC for tax purposes: the S-Corp is better. Hands down.

But the LLC is simpler because a one-person LLC doesn't exist for tax purposes, it's just an extension of its owner. The cost of this simplicity is significantly higher taxes once you make enough money for taxes to matter.

Whether the S Corp is better than a plain LLC is up to the business owner, and it doesn't just have to be about money.

You are just wrong that an S Corp is better for me. I've done the math, I know the difference, I made the choice with other factors in mind as well.

> There is no dispute amongst tax advisors about whether a single-owner S-Corp is better than a single-member LLC for tax purposes: the S-Corp is better. Hands down.

Funny thing is that one of the three accountants I went to disagreed with this, so it's definitely not "hands down."

The LLC is only better so long as it remains a disregarded tax entity with no employees, because once either of those happens, it becomes significantly more complex than an S-Corp. So if you're fine not ever having partners or employees, and paying more in taxes for the sake of slightly more simplicity, then yes, the LLC is better.

But if you want partners, or employees, or saving money on your taxes, then the S-Corp is better. And if an accountant is telling you otherwise, then it's only because you make so little money that it doesn't matter whether you have a legal entity or not.

And yes, I know you don't have an S Corp. I was wondering how you would pay yourself from such a corporation, considering you have zero revenue.

When you have a single-member LLC, you take "distributions," which basically means you withdraw money from the company and put it into your personal account. It's technically a dividend.

I'm having a tough time understanding how there's money going out of an LLC without money first going in the LLC.