I have a game developing business that is a sole proprietorship and am considering if it should be a sole proprietorship, limited liability corporation, or corporation as I grow nearer to releasing the game.

A corporation is treated as an entity and protects you from some personal law suits. It is also costly or time consuming to report the taxes. And it costs money to set up the corporation.

I am concerned mainly about law suits and I do not have a lot of money. Such as my software causing costly problems on people's computers.

Secondly, Is getting additional insurance for protection against law suits possible and how is it done?

Thank you,

Josheir

A corporation is treated as an entity and protects you from some personal law suits.

Financial stuff is going to rely on your personal guarantee until your business has a value measured in millions of dollars. Most other liability will come against you personally as business owner. About the best thing it helps with is when the business dies, which statistically is probably going to happen. The exact number varies, but well over 90% of businesses fail within a few years. The business structure helps minimize those losses.

And if your business succeeds, the business structure helps you buffer the money from your personal funds.

It is also costly or time consuming to report the taxes.

It can be costly, based on the state. Many states have fees in the $40 to $100 range. Some are even lower that that. However, a few states and cities (particularly California and New York) have terribly high costs.

Beware of of companies that help with setting up businesses. Many charge high fees for things like getting an EIN (which is a three-minute phone call to a free automated system) or submitting documents (which can generally be sent electronically on a free web form). Assuming the US because of business names you used, most big cities have a government office for the Small Business Administration (SBA). Pay them a visit and they can help with most of the process for free.

As for taxes, self-employment taxes and corporation taxes are higher than what you pay as a worker for income, and many people who aren't used to this feel this is double taxation. Instead it is just a tax that most wage-slaves never experience so they're surprised when they discover it exists. Taxes are on your profits and revenues. If you aren't earning much money or can document a financial loss you don't really have to worry too much about that. Be careful about that, you need to show a profit at least 3 of 5 years unless there are a few special conditions that exist. If you show a loss for any three of the first five years you'll get a special investigation for potential tax evasion.

And it costs money to set up the corporation.

Welcome to the grown up world. Registering for a business triggers many government services. You gotta pay for it.

I am concerned mainly about law suits and I do not have a lot of money.

Then you may not be in a position to start a business. Instead, keep it as a hobby that earns a small amount of money to you directly. If you want to operate under a different name, get a DBA license (Doing Business As) which works well if you want to contact people as "Josheir's Computer Repair" rather than your actual name. The money counts as direct personal income in the US, and you need to file tax forms Schedule SE (Self Employment) and 1040 Schedule C (Profit or loss from a business), so track the money that comes in so it gets reported accurately.

Is getting additional insurance for protection against law suits possible and how is it done?

Yes it is possible.

There are several types. The one closest to what you describe is generally called "Professional Liability Insurance", or "Errors and Omissions Insurance". You contact insurance companies, you explain the details of your startup including the nature of your business, the number of customers, the revenue values, and details of the business. You'll probably also want property insurance. Depending on your location some other types of insurance may be legally required. The SBA office can walk you through those.

If you are running your business from your home and people come to your location, your homeowners insurance or renters insurance may require some changes to the account.

If you hire people to work for you, you may also be required to have workers' compensation insurance, unemployment insurance, and disability insurance.

Again, it costs money to start a business. If your business is a hobby you might want to operate differently than an incorporated business.

Geeze I started my business over five years ago and have shown no profit yet. I am concerned now, what can I expect to happen?

Thanks,

josheir

What are the special conditions?

Thank you,

Josheir

Geeze I started my business over five years ago and have shown no profit yet. I am concerned now, what can I expect to happen?

What are the special conditions?

Again assuming the US since you didn't specify and it seems likely...

You must have economic activity for it to be a business. You write that you have had a business for over five years, but if you've had no economic activity then you haven't had a business.

Also you are writing questions about forming a corporation from a sole proprietorship, but a business entity doesn't actually exist until you register with the government. You don't have a sole proprietorship if you haven't filed the paperwork for it.

if you actually started a business (which it doesn't seem like you actually do) then you are required to report financials to the IRS for tax purposes at least every year. This includes a business as a sole proprietorship. As a small business that probably means 1040 Schedule C and Schedule SE, as above.

It is the IRS (not you) who decides the tax status, and it is done so by an audit. If you claim a business loss for three years in a row, or three of four years, or three of five years, you are almost certainly going to be automatically flagged for an audit by IRS software.

As for the special case, looking it up on the IRS website there are nine factors they examine: Is the business run in a businesslike manner? (Meaning proper bookkeeping and records.) Does the business have the necessary expertise to run the business? Do business workers spend the time and effort necessary for the business to succeed? Is it likely the business will appreciate value over time? Do the founders/executives have a track record of success? Is there adequate history if income or loss? Are there occasional profits relative to the investments? What is the owner's financial status? Is the business being pursued for pleasure or recreation?

With all of that as a whole, a business can operate on a loss for many years. Take for example a software startup. Perhaps the business founders are already multi-millionaires from prior ventures and they are starting a new company by self-funding the idea. They expect it will take three to four years before reaching profitability and are investing about $20M of their personal money. They operate as a business, hire workers as a business and maintain business records. They have hired the right people for the jobs, people are working full time on standard business hours. The business is likely to eventually release a product and hopefully succeed, and the founders have a track record of success as that's where they got their money from. The individuals track financial history. Though they don't have profits yet due to the investments they are likely to. The owners's financial status is not presently dependent on the income but has a long-term expectation to do so, and the business is not pursued for pleasure or recreation. That business loss is allowed.

Now consider a hobby business. The person has minimal economic transactions or investment and there is minimal paper trail or bookkeeping. The person may have some expertise on the products but has minimal experience running a successful business. The person is spending minimal time or effort, perhaps a few nights per week or some weekends. It is unlikely the entity will increase in value. The founders/executives have no track record of business success. There is little or no history of income/loss related to the business. There may be occasional profits but they are inconsequential relative to the value of hours invested. The owner's financial status is not dependent on the business but unlike above, has little real expectation of long-term investment. Finally, such a business appears pursued for pleasure or recreation as it only accounts for occasional weekend or evening activity.

If you claim losses from the business and the IRS determines it is actually a hobby, you will likely be required to repay deductions you've taken and pay penalties for filing your taxes with material errors. That's a less aggressive way of saying "fraud". You say 'oops', pay the fine, and are forbidden from taking the deductions for several years.

Looking further, there is also a form you can file if you are in that first example of knowing your business won't generate profit for a few years. It notifies the IRS that you know you are in violation of the 3 of 5 rule, but that you believe you are an exception. It probably generates a different flag in the computer system and triggers a different type of investigation than a tax audit.

You don't have a sole proprietorship if you haven't filed the paperwork for it

Not true. https://www.sba.gov/starting-business/choose-your-business-structure/sole-proprietorship

Not true.

I'm guessing you missed the details of the discussion and details of the page.

On one line of the page they talk about how you may already have one even if you haven't done paperwork yet, but then immediately follow it with the legal requirements for licenses and permits, the need to register for a DBA name, the requirements for reporting on the tax forms, and some bookkeeping requirements.

Taken on its face if both are true then he's got a problem: One he has been running a business for five years, and two there have been no documents filed whatsoever. Put them together then what remains is that he's been committing tax fraud for five years.

Businesses are economic. As far as taxes and the other law I'm aware of are concerned, if there is no economic activity then it is not a business, full stop. It may be a person's hobby or pastime, but is not a business.

Based only on what I see in this topic this project is not an actual sole proprietorship, just a hobby.

On one line of the page they talk about how you may already have one even if you haven't done paperwork yet

That was my only point. No formal action is required to form a sole proprietorship. There is no paperwork to file to make it happen.

On one line of the page they talk about how you may already have one even if you haven't done paperwork yet

That was my only point. No formal action is required to form a sole proprietorship. There is no paperwork to file to make it happen.

Paperwork is absolutely required to keep it going from year to year, at the very least tax paperwork is mandatory. My point was that if the business had been going for five years as claimed, and no paperwork of any type has been filed as claimed, then something illegal is happening.