Do business as a self-employed person or company (s.r.o)?
A very common question that clients give us is the question of whether to do business as an entrepreneur or whether the so-called "through s.r.o.". This question is almost always accompanied by another question, which of these variants is more advantageous for tax purposes.
Are you also in a situation where you decide between self-employed and s.r.o?. So this article is for you.
Doing business as a self-employed person or as an owner (partner) s.r.o. they differ fundamentally in many parameters in all stages of business development (establishment, registration, active activity, termination, etc.). You will most likely be very surprised that we do not classify the tax aspect as the most important aspect.
We firmly believe that there is no such thing as a "golden best rule or best option", but that both options (OSVČ and s.r.o.) have their advantages and disadvantages. We always recommend assessing the specific conditions, risks, opportunities and needs of the individual people who are going to do business.
Self-employed - This is a self-employed person, ie a self-employed person with the status of a natural person who does business on the basis of a trade license using a free or licensed trade.
S.R.O. - A limited liability company is a legal entity that can be established by one or more partners. S.R.O. it must create share capital by law and is an independent legal entity which must have its own director. The managing director acts on behalf of the company, ie he takes legal action with his signature.
We recommend our clients to address the issues in the following order:
1. Risk - How important is personal business risk for you? Is it likely that you may face business losses?
2. Time and administrative complexity - Do you plan this business as a short-term idea or as a long-term matter? Can you imagine a situation where you have to run your own business as an owner, have your own employees and deal with business and administrative management?
3. Creating value - Do you trust your idea or business so much that you can imagine it as a benefit, for example, for your children in the future?
4. Financial resources and ownership of business results - Do you think that you will need external resources such as loans, credits, etc. to start or further develop your business? Do you understand the difference between who owns the money earned in both variants?
5. Taxes and revenue optimization
You may be shaking your head and asking "why should address this at the beginning, when I have no idea if I'm going to be successful in business and what will come of it", but believe us, it's better to decide when you can see the matter more comprehensively.
The risk of business and the personal impact of problems in business are very often neglected, which, however, was de facto one of the basic legal pillars of the legal institute of "company" (in our case s.r.o.).
When you establish a s.r.o., you show the will to establish an independent legal entity, which itself takes steps that have legal consequences, and which can own property or, on the contrary, owe someone. In practice, this means that it is s.r.o. that is responsible and the partner is only liable up to the amount of his unpaid deposit. As a natural person - partner s.r.o. - so you guarantee a much smaller share of property than a self-employed person (OSVČ).
When you start a business as a self-employed person, you have a relatively large responsibility, where you can pay for any damage with all your personal and family property.
The company gives you a clear advantage in separating your private property from the business of your s.r.o. However, we remind you that the issue of liability of the partner and the managing director is of course very extensive and that in certain circumstances (associated with, for example, criminal activities of the partner or the managing director), this personal property may not remain unaffected.
2. Time and administrative complexity
If a person decides to start a business as a self-employed person, obtaining a trade license is a very simple, easy and fast matter (that is, if you know how to do it). When you stop enjoying business, you can easily interrupt or even cancel it. You can just as easily expand your business with new types of trade activities.
Establishing a company is also not difficult today, you just need to go to a notary and establish it by direct entry in the Commercial Register. Today, there is an option to buy an already established company, but this option can be more costly and has its limitations. Establish s.r.o. but just as a temporary matter is not entirely reasonable. Whether the company is active in business or not, legally still exists, you need to address the question of the existence of the company's headquarters, accounting, legal issues. Liquidating a company, ie securing its legal demise, is no longer such an easy task. On the one hand, you need the assistance of an expert (notary, law firm, liquidator, etc.) and on the other hand, the liquidation of s.r.o. often more expensive than the actual establishment of s.r.o.
But what is important for us at this point is the longevity of s.r.o. Clients are advised to consider s.r.o. If they themselves identify that the establishment and development of a business will take years. Years when the partner and the managing director have to deal with it on an ongoing basis. In practice, it often happens that the founding partner, thanks to whom the company initially provided services or sold goods, over time moves to the position of who no longer provides active activities on behalf of the company, but manages the company, looking for business opportunities, etc. The active services company then has its employees.
Some clients think that when a company is not active, they do not have to maintain bookkeeping, but this is a big mistake. Even an inactive company must open its accounts, it may have costs, for example, to rent the company's headquarters or bank fees. It is therefore always necessary - even for an inactive company - to have completed accounts and to prepare financial statements in the form of balance sheets, income statements and notes in the financial statements-
3. THE QUESTION OF EASY BUSINESS SALES
If you do business as a self-employed person, it does not create any value (investment) that you could or could easily sell. Of course, you are creating your personal brand, but you cannot easily sell yourself as a brand (we do not mean invoicing your services, but selling your business once you decide to quit). Your business as a self-employed person is connected only with you as a natural person and with your name.
If you do business as a s.r.o., you can easily sell your share in the company to potential buyers and evaluate everything you have invested in the company (personal time, financial resources, etc.).
In other words, as a self-employed person, you get paid by your customers for your work, but you do not create any other easy-to-sell investment value. In company, it receives for its activities payment form customers, but at the same time it can create (if successful) value for its partner and then the partner can sell (he can sell his share or the whole company).
Of course, even an individual can sell their business, but it is not an easy matter. It is always necessary to consult the details with legal, accounting and tax experts.
4. FINANCIAL RESOURCES AND OWNERSHIP OF RESULT OF BUSINESS
Some clients tend to be surprised that the money earned by their s.r.o. are not in their legal ownership as persons. As already explained, s.r.o. is a separate legal entity, ie s.r.o. is the owner of the money paid by customers, the owner of other assets and all liabilities and is accountable to its creditors. The partner owns "only" a share in this company and thus owns the company's assets indirectly.
In the case of self-employed persons, on the other hand, the money earned is therefore entirely yours and no one pursues the purpose of their use, ie whether they use it for their own private needs or whether for business purposes. If you use them for business purposes and want to claim the expenses as tax deductible, you must prove the expenses, but it no longer proves your private payments to anyone.
In s.r.o. each expense must be recorded in the accounts and the purpose of the use must be known. The owner of the company cannot simply take the company's money (from the cash register or from a bank account), because it does not belong to him. He can borrow money in the form of a repayable loan, or he must choose another possible way to get money from the company (salary, payment of profit shares, etc.). From this fact, you will certainly feel that the administration associated with the s.r.o. will be higher than the records of self-employed persons.
Another important point is the possibility of obtaining financial resources. It can be said that s.r.o. has better access to bank loans, but the ability to support or expand business by entering the s.r.o. a new partner joins. In principle, you cannot combine your business with another self-employed person and act together legally inseparably, while in s.r.o. it is possible. Contributions from partners are often the most important financial resources for business development. Business through multiple partners can be better coordinated thanks to the partnership agreement, which is the charter of s.r.o.
5. TAXES AND TAX OPTIMIZATION
In most cases, clients are interested in this last point in the first place. Taxes as a mandatory statutory payment to the state budget is a key indicator that affects your net business income, but at the same time it is, with some exceptions, a payment that you cannot avoid (but you can legally optimize). At the same time, the amount of the tax burden and the scope of taxation may vary according to the political will and the needs of the economy, so in our opinion it is not reasonable to decide only on the basis of the tax burden.
As owner of a company, you have more freedom. No one can force you as a partner to pay enormous amounts in social and health insurance, because you simply get the remuneration in a minimum amount that is not subject to social insurance and which is only subject to a minimum health insurance rate. So you don't have to pay a high salary and you can only focus on paying out profit shares that are not subject to social and health insurance. On the contrary, if you want to pay a monthly remuneration as an employee, the remuneration or wage is subject to social and health insurance, so from the point of view of the tax burden you will be worse off than a self-employed person.
The disadvantage of s.r.o. in the case of taxes, the fact is that there is no such thing as a flat-rate expenses (calculated as percentage from income). Self-employed, unlike S.R.O. can apply for flat-rate expenses, up to the amount of two million crowns of income (note: for 2018 the maximum was 1.2 million CZK) . "Flat rates" range from 30% to 80%. The most common flat rate is a flat rate of 60% for free, bonded and licensed trades.
S.r.o. therefore must keep the accounts which form the basis for processing the income tax return. S.r.o. can only tax such amounts that are provable from accounting. Thus, if purely theoretically s.r.o. reached revenues of CZK 1 million (fictitiously without costs) and self-employed income also amounted to CZK 1 million, the total burden of both types of business will be diametrically different.
The corporate income tax rate is 19%, the personal income tax rate (OSVČ) is 15%. Income tax rate on profit shares paid by s.r.o. to the owner also amounts to 15% for its partner (the company therefore first taxes its result at a rate of 19% in order to deduct 15% withholding tax from the payment when paying the net profit).
We always recommend calculating and estimating the resulting tax impact, preferably as part of a business plan. Only on the basis of detailed information about a planned business such as a self-employed person or a company can the question of what will actually be more advantageous in terms of taxation be properly answered.
And a short summary in conclusion:
When to consider doing business as company (S.R.O.):
I do not want to be fully liable with all my personal property for any damage caused in the business,
I want to do business in the long run, build a company in the long run and increase its value.
I am interested in building something that can be sold in the future (a share in a company), or my children can inherit my share, for example.
I don't mind running the company and I expect that at some stage of the business I will probably need my own employees, for which the company must earn.
I agree that to terminate the business of s.r.o. (deletion from the Commercial Register) is not a completely simple and inexpensive activity.
I agree that the company must keep accounts (which I must ensure as an executive officer) that s.r.o. has more administrative complexity (which will cost me time and money).
I understand and agree that the money paid by customers to the company belongs to s.r.o. and not me, ie I have to determine the way money from my s.r.o. I will gain.
It suits me that I will be able to invite another partner or partners to the company and obtain capital for further development.
It suits me that I can easily change the partnership agreement (eg change shares).
When to consider doing business as a self-employed person:
Wherever I want to create my personal approach to the customer, I offer services on my own behalf and I provide services myself.
I do not mind that I am liable for any damages with all my personal property.
It suits me that I can easily interrupt or close my business at any time.
I like the lower administrative complexity, I don't have to keep accounts (with a few exceptions) and I can apply flat rates.
I like the taxation of my income as a self-employed person (flat-rate expenses, income tax, social and health insurance, handling of private expenses).
I do not want to address issues related to the management of s.r.o., which could burden me.
I don't need to invite any investor / partner.
Connect with experts and spend some time discussing the important way you envision the business.
Always get explained with the related legal circumstances, administrative complexity, methods of possible remuneration (obtaining business income), related future tax circumstances (especially VAT and the impact on your prices).
Prepare at least a basic financial plan (estimate of sales / income and expenses / expenses, calculation of tax liability) so that you have an idea of the total tax burden and the development of net income / profit.
Take your time, think, and only then make a decision.
Don't be tempted by some opinions on various discussion forums, which can have criminal-law consequences for you (such as invoicing by an executive or a partner to your own company, invoicing of a performance that never occurred, etc.).
Remember that there is no one optimal or "golden" variant of business. It always depends on several parameters that can change, and in reality, each business is as individual as each person is.
Do not hesitate to contact us if you need advice in accounting, tax or legal areas, or directly register a self-employed person or establish a s.r.o. We are at your disposal.
Wishing you a nice day,
Your TrimmTax team