This page is for informational purposes and should not be considered a replacement for professional financial or legal advice. Please consult your accountant and/or lawyer for details as they pertain to your particular situation.
This page provides a framework for individuals and small groups who receive income for their nonprofit work – both as compensation and in direct support of their projects and/or organizations.
A 501(c)(3) is NOT needed to receive income or engage in nonprofit work. The business model(s) below show an easy alternative or starting point.
Being self-employed, an independent contractor, or a sole proprietor are essentially the same thing. This model can be used for commercial AND nonprofit purposes.
A sole proprietor likely goes through a few extra steps to establish a business name and perhaps a separate business tax ID number, but not necessarily and someone who is a self-employed independent contractor can also use a DBA – “Doing Business As” trade name.
An individual is automatically considered self-employed if they earn more than $400/year of non-wage income (whether or not they receive an annual 1099 income report). For example, even someone who just occasionally mows lawns for pay would count.
Instead of a W-2 annual income report (as with waged employees), people who are self-employed do NOT have a legal separate existence from the business from which they receive income.
Income is declared on the individual’s 1040 tax return under Schedule C. Most common work-related expenses are detailed there and are subtracted against the year’s total income. This “net income” that remains on December 31st is taxed (see below for more details).
It’s worth noting that it’s possible to receive both waged (W-2) income and self-employed/independent contractor (1099) income. For example, someone may have a full-time job for another business (W-2) and their own income-generating side job (1099).
Quick Tax Overview
Income received as compensation (and any extra income not reduced by covered expenses) is taxable.
The 1099 tax rate is based on the W-2 rate, PLUS an additional 7.65% taxes. These “extra” taxes are usually covered on W-2 wages by the employers paid share of Social Security (6.2%) and Medicare (1.45%) as of 2017.
Our recommendation is to set aside 1/3 of total taxable compensation (not expense-related income) in a separate savings account. Additional taxes apply at higher income levels. Check with your accountant for details.
IMPORTANT: The IRS requires quarterly reports and payment of Estimated Taxes based on the income from the previous year. Late payments and/or year-end payments will likely incur fees and penalties.
Organizations that provide funds to an individual or group (such as a grant or stipend), will often require completed W-9 form. This simple form is just an official way to confirm the name, address, type of business (sole proprietor), social security number or business tax ID (see below for EIN details) for the year-end 1099.
While an EIN – federal tax ID number – for a business is NOT needed, many people prefer to get one for a business banking account and to provide greater distinction between themselves and their organization (though for IRS tax purposes, they are the same). This Employer Identification Number – EIN (also known as a Federal Employer Identification Number -FEIN) can easily be obtained online before securing a banking account. Click here for online business tax ID number — EIN registration.
The self-employed independent contractor / sole proprietor is the easiest category under which a business can be operated. A nonprofit can also use this model.
This category includes anyone receiving more than $400 in non-wage income in a fiscal year and it only requires reporting on a Schedule C of personal 1040 tax returns. This is not to be confused with the $600 threshold for an organization/business to send a 1099. Regardless of 1099 wage reports received, individuals are required to report non-wage income that totals $400 or more from all sources combined.
The sole proprietorship is NOT a legal entity. While there may be a trade name (often a DBA – a “Doing Business As” name), a sole proprietor is someone who is self-employed and is personally responsible for the debts incurred.
A sole proprietorship can operate under the name of its owner OR it can do business under a trade / “fictitious” name, such as Nancy’s Nail Salon. The fictitious name is simply a trade name/DBA. It is easily be obtained online. A DBA is basically a nickname… it does not create a legal entity separate from the sole proprietor/owner/independent contractor.
The sole proprietorship is a popular business form due to its simplicity, ease of setup, and nominal cost. If desired, a sole proprietor can register their name and get a business checking account. Otherwise, a separate personal checking and/or savings account is recommended to keep the funds distinct and the record-keeping more manageable.
If needed, anyone engaging in income-generating activities should secure local licenses as required by law. Someone who is merely self-employed by default may not have to do anything, but certain fields require special permits and licenses.
A disadvantage of being self-employed or running a sole proprietorship, is that the indivdual remains personally liable for all debts. So, if a sole proprietor business runs into financial trouble, creditors can bring lawsuits against the business owner. If such suits are successful, the owner will have to pay the business debts with their own money.
The owner of a sole proprietorship typically signs contracts in their own name, because the sole proprietorship has no separate identity under the law.
The sole proprietor will often have checks written to them in their name, even if the business uses a fictitious name. Sole proprietors can commingle personal and business property and funds — something that partnerships, LLCs and corporations cannot do.
Sole proprietorships often have their bank accounts in their own name, but can have a business account if they register for a business tax ID number (check federal and state laws).
Sole proprietors need NOT observe formalities such as voting and meetings associated with the more complex business forms. Sole proprietorships can bring lawsuits (and can be sued) using the name of the sole proprietor owner. Many businesses begin as sole proprietorships and graduate to more complex business forms as the business develops.
Because a sole proprietorship is indistinguishable from its owner, sole proprietorship taxation is quite simple. The income earned by a sole proprietorship is income earned by its owner.
HINT FROM AWFW: Spending down the bank balance from business income by year-end will reduce taxes. Similarly, accepting income in the early part of the year provides more time and opportunity to spend down the income.
A sole proprietor reports the sole proprietorship income and/or losses and expenses by filling out and filing a Schedule C, along with the standard Form 1040. Your profits and losses are first recorded on a tax form called Schedule C, which is filed along with your 1040. Then the “bottom-line amount” from Schedule C is transferred to your personal tax return. This aspect is attractive because business losses you suffer may offset income earned from other sources.
As a sole proprietor, you must also file a Schedule SE with Form 1040. You use Schedule SE to calculate how much self-employment tax you owe. You need not pay unemployment tax on yourself, although you must pay unemployment tax on any employees of the business. Of course, you won’t enjoy unemployment benefits should the business suffer.
Sole proprietors are personally liable for all debts of a sole proprietorship business. Assume that a sole proprietor borrows money to operate but is unable to repay the loan. The sole proprietor is liable for the amount of the loan. Even worse, if a sole proprietor (or an employee) is involved in a business-related accident, the sole proprietor can be sued.
Pros & Cons
The advantages of a sole proprietorship include:
- Owners can establish a sole proprietorship instantly, easily and inexpensively.
- Sole proprietorships carry little, if any, ongoing formalities.
- A sole proprietor need not pay unemployment tax on himself or herself (although he or she must pay unemployment tax on employees).
- Owners may freely mix business or personal assets.
The disadvantages of a sole proprietorship include:
- Owners are subject to unlimited personal liability for the debts, losses and liabilities of the business.
- Owners cannot raise capital by selling an interest in the business.
- Sole proprietorships rarely survive the death or incapacity of their owners and so do not retain value.
- One of the great features of a sole proprietorship is the simplicity of formation. Little more than buying and selling goods or services is needed. In fact, no formal filing or event is required to form a sole proprietorship; it is a status that arises automatically from one’s business activity.