Choice of Business Organization

Your Personal Bottom Line

Your tax situation will be different than the scenario with Mary. Nonetheless, this scenario demonstrates a couple of crucial points. First, even a modestly profitable business (such as Mary's in year 2), can get blindsided by the cumulative effect of regular income taxes and the Self-Employment Tax. For this reason alone, I urge entrepreneurs to incorporate their business as soon as they reasonably expect their business to turn profitable. Second, S-Corporations (or partnerships if you can find additional shareholders) offer a middle ground between Schedule C and regular C-Corporations. Paying yourself a salary in an S-Corp, which sounds like a disadvantage, has the effect of increasing losses and minimizing profits.

Your personal decision on the matter should be made after weighing factors such as your other income, your marginal tax bracket, expectations of future profits, and your personal tolerance for record-keeping and dealing with the IRS. (Incorporating requires more paperwork, but remaining a Schedule C means higher chances of being audited.)