Most everyone could do with a little more cash these days, and a side hustle is a great way to keep your “day job” or core business and still make extra income. But what happens when your side hustle gains traction, and you want to make sure it is legally protected? When does the Internal Revenue Service (IRS) need to know? What about your state’s Secretary of State or Department of Revenue? Here’s what to know to keep your side hustle on the right side of the law.
Is Your Side Hustle a Hobby or Business?
Per the IRS, you can distinguish between a business and a hobby by considering the facts and circumstances related to the activity. A hobby is generally an activity not performed to make a profit. However, no one factor alone is decisive. The IRS offers the following nine factors when determining whether an activity is a business engaged in making a profit:
- Do you carry on the activity in a businesslike manner; do you maintain complete, accurate books and records?
- Are there personal motives in carrying on the activity? This aspect is very subjective, as many people engage in activities they derive personal pleasure in whether or not they make a profit. For this reason, you must consider the other factors as well.
- Does the time and effort you put into the activity indicate you intend to make it profitable?
- Do you depend on income from the activity for your livelihood?
- Are the losses incurred while performing the activity due to circumstances beyond your control? Or are the losses typical in the startup phase of your type of business?
- Do you or your advisors have the knowledge needed to carry on the activity as a successful business?
- Were you successful in making a profit in similar activities in the past?
- Has the activity made a profit in some years, and how much profit does it make?
- Do you expect to make a future profit from the appreciation of the assets used in the activity?
If you don’t know if your side hustle activities are considered a business venture, talk to your accountant and get an expert’s opinion. You don’t want to get into trouble with the IRS.
If your goal is for your side hustle to make a profit, but you lose money on the project, the IRS allows you to deduct the loss from your other income source, as long as the side hustle meets the conditions of a business startup.
Startup-related expenses include doing research and market research, taking surveys, getting advice from attorneys, and advertising your launch. You can also deduct organizational expenses, such as the costs related to setting up a partnership, corporation, or LLC. The expenses must be ones that would be deductible if your business were already operating and must be paid for or incurred before the day you “opened” your side hustle for business.
It’s important to note, portraying and running your side hustle as a genuine business so you can take advantage of IRS deductions means the impetus is on you to take the appropriate legal steps to register, protect, and comply with necessary business regulations.
Making Your Side Hustle a Real Business
You have several options available to form your side hustle as a legal business with varying legal protections.
- Sole Proprietorship – The easiest, although the riskiest, form of legal structure is the sole proprietorship. You don’t need to register your side hustle with the state, and there are no corporate requirements unless the type of business needs specific licenses or permits. However, if you brand your project with any other name than your own, you’ll need to file for a fictitious name, also called a DBA (Doing Business As), with the Secretary of State’s office in your state. Make sure you keep your personal and business finances separate. Most banks require you to obtain a Federal Tax ID number before opening a business bank account. Protections are minimal with a sole proprietorship, as there is no legal separation from the company; therefore, the sole proprietor is personally responsible for any debts or liabilities.
- Partnership – If you are running your side hustle with another person (or persons), you can structure your business as a partnership and share in the responsibility. Similar to a sole proprietorship, there is no need to file paperwork with the state unless the partnership needs to file a DBA. The partnership begins once the partners draft a partnership agreement detailing the division of ownership and duties. Again, there is no legal separation between the business owners and the company in a partnership, although the liability risks are now divided among the partners.
- C Corporations – If you think your side hustle might someday become a substantial business venture or if you’re looking to attract investors, incorporating is an option worth exploring. C Corporations are legal entities separated by a “corporate veil” from the owners and are formed under state laws, meaning they must register with the state and follow state laws for corporations. Business owners are considered employees of the corporation and therefore have a substantial degree of personal liability protection. As a state-formed entity, C Corporations are required to file Articles of Incorporation, create corporate bylaws, form a board of directors, hold regular board meetings, and pay all state-required fees to maintain good standing.
- Limited Liability Company (LLC) – Like a C Corporation, forming an LLC can provide the owners’ liability protection from the business’s activities and are also state-formed entities deemed as separate entities from its members. Although LLCs must file Articles of Organization with the Secretary of State, there are fewer compliance requirements. LLCs should also create an Operating Agreement that outlines how the business divides its profits and losses among the owners. You can structure your LLC as single-member or multi-member.
Other Ways to Protect Your Side Hustle
Structuring your side hustle as a legal entity is the best way to protect your concept, especially if someone tries to steal your idea. Showing that your business is in good standing in your state means you’ve done what’s required and are up to date on your compliance obligations.
Besides legally structuring your business, you can also protect your side hustle by registering a trademark with the United States Patent and Trademark Office (USPTO). A trademark includes any word, name, symbol, or device, or any combination, used, or intended to be used, in commerce to identify and distinguish the goods of one manufacturer or seller from goods manufactured or sold by others, and to indicate the source of the goods. The trademark process is quite involved but well worth the effort if you want to make sure your brand is legally protected. CorpNet can help prepare your application and answer any questions you have about the steps to take.
Depending on your business type and physical location, you may be required to have one or more business licenses and/or permits from the state, local, or possibly federal level. Licenses may include a general business license, zoning, and land use permits, sales tax license, health department permits, and occupational or professional licenses.
To protect your side hustle, you need to take your legal obligations seriously. Let CorpNet set you on the right path from the start to avoid difficulties down the road and ensure your side hustle’s success.