Many freelancers want to form their LLCs. Interest in this is growing. First, it’s okay to have an LLC to freelance. You also don’t need it to deduct business expenses. Possessing one won’t necessarily result in a reduction of your tax expenses.
To save the most, consider your 1099 earnings when evaluating the benefits of an LLC. What is their main advantage? It ensures the safety of your assets in the face of legal liability. So should I form an LLC as a freelancer? Why should I start an LLC as a freelancer?
This article will explore the pros and cons of starting a business entity like an LLC. We’ll compare this to staying a sole proprietor. Next, we’ll discuss how LLCs can help some freelancers. They can reduce their self-employment taxes. Let’s dive right in!
What is an LLC?
LLC is an acronym for “limited liability company.” It’s a business structure. It allows for separating business and personal assets. This protects from lawsuits and business debts.
If someone sues your LLC, your personal assets will remain protected. No worries, your business’s creditors won’t be able to pursue them either. This type of legal separation can help in situations. For example, you are doing freelance work alongside a regular job. You want to avoid conflicts with a non-compete agreement.
How much will an LLC cost me?
States set up LLCs. So, the setup costs and required paperwork may differ. Be prepared to pay anywhere from $40 to $500, though.
Typically, this will be something other than a one-time payment. In many states, LLCs have ongoing costs. These include franchise taxes and reporting fees.
How LLCs compare to other business structures
LLCs are unique in the realm of business structures. They offer better legal protection than sole proprietorships. They also offer more flexibility than corporations.
Let’s look at how LLCs compare to other options for running your freelancing business.
LLC vs. corporation
There are alternative methods to establish a business entity aside from an LLC. Another alternative for accomplishing that is a corporation.
Like LLC owners, the owners of a corporation are not personally responsible for business debts. However, the corporation structure may offer less flexibility than an LLC. It also has more compliance obligations.
In the grand scheme of things, corporations are better for owners. They intend to attract investors from outside. Freelancers wish to protect themselves from legal and financial responsibilities. Forming an LLC is a better choice for this.
LLC vs. sole proprietorship
As stated earlier, the main advantage of the LLC is not taxes. It is its legal implications. When you create an LLC, you establish a distinct legal entity. This split is crucial. It ensures you have the needed protection for your assets and debts.
If you own an LLC, the only risk is limited to the money you invested. Your personal assets, such as your house and car, are secure. But you will still owe any debts that you guarantee.
When you are a sole proprietorship, note that you won’t get the protection of a corporate shield. It won’t protect your personal assets. Your personal assets are at risk without proper legal safeguards or precise financial arrangements. These assets include your home and car. This could happen in a lawsuit or if your business faces creditors.
There are additional advantages to establishing a separate entity for your business. Applying for an Employer Tax ID (EIN) lets you use it in place of your Social Security Number. You can do this when submitting Form W-9 to vendors.
Setting up a business bank account is another option available to you. Many freelancers find it helpful for bookkeeping to keep their business income and expenses separate. They keep them separate from their finances.
How LLC taxation works
Legal liability can be limited by forming an LLC. However, it does not guarantee a reduction in your tax liability.
Imagine running an LLC alone, making it a single-member LLC. From a tax perspective, the IRS will consider it similar to a sole proprietorship by default. That implies you’ll still be issued a 1099 and must handle self-employment tax.
You have a partnership LLC, so it’s run by someone else. You will also need to address self-employment tax. It is a default requirement. Members of the LLC will each report income and losses from their share of it on their tax returns.
That being said, LLCs can face quite complex taxation. That’s because they lack a distinct tax rate classification. You can choose corporate taxation for your LLC. This is instead of being taxed as a sole proprietorship or partnership. In that case, you have two options: C corporation taxation and S corporation taxation.
When an LLC is taxed as an S corporation
Small businesses often prefer S corporations. Unlike C corporations, they do not face the issue of double taxation. Instead, the profits flow through to the income tax returns of individual shareholders. That implies that shareholders are only taxed on their personal income taxes once.
Not having double taxation makes the S corporation appeal to LLCs. It is an excellent choice for corporate taxation. Still, there are specific requirements. Your LLC must fulfill them to be an S corporation for tax purposes. First, it is crucial to have 100 or fewer shareholders. Also, note that the shareholders must not include businesses or non-resident aliens.
When an LLC is taxed as a C corporation
C corporations are responsible for paying corporate income tax on their net income. Meanwhile, shareholders are responsible for paying income taxes on their dividends. They refer to this as “double taxation.”
Double taxation is a big problem for many LLCs. It makes C corp taxation impractical. Due to its rarity, it’s not a common choice.
C corps have an advantage in taxation. Owners have more flexibility to deduct expenses for employee benefits. These benefits include health insurance, retirement plans, and life insurance. However, this may only apply to a select number of freelancers.
How an LLC taxed as an S corp can help high-earning freelancers save
Choosing S corporation taxation can lead to tax savings. This is for freelancers who earn a lot from their businesses. To make this worthwhile, you must earn enough to pay yourself and have money left over.
When an LLC is taxed as an S corp, self-employment tax applies only to your “salary.” The remaining amount can be paid to you as a profit distribution and will not be subject to the 15.3%.
The IRS requires individuals to pay themselves “reasonable compensation.” This is important to note.” You cannot call most of your earnings a profit distribution. You do this while only giving yourself a $1,000 salary.
There are expenses associated with this approach. If you pay yourself through your S corp, you must deduct income. You must also pay payroll taxes monthly or quarterly. Service fees and the fees for filing S corp tax returns are associated with that.
Does it make sense to choose S corp taxation?
Many people consider switching to an S-corporation. They do this after their net income surpasses $30,000. They deduct business expenses. Choosing S corp taxation can lead to significant savings on self-employment taxes. With a net income of $30,000, there is an opportunity to save approximately $2,000. If your net income rises to $40,000, you can save around $3,000.
Given the circumstances, if your payroll tax fee is $100 per month, totaling $1,200 for the year, and your S corp tax return fee is $800. Then, your total costs from the shift to an S corp will be $2,000. That could negate any savings you’ve accrued from self-employment tax.
Ultimately, it’s crucial to consider the cost of S corp taxation. Compare it to the benefits of avoiding self-employment tax. It may take time to determine if your income comes solely from a part-time job. Besides, the greater your income from freelancing, the more advantageous it becomes.
Why should I form an LLC as an independent contractor?
1. You can easily open a business bank account.
When you start an LLC, you will get an Employer ID Number (EIN). It serves as a tax ID for your business. You can enjoy the benefits of making your business a separate legal entity. It will have a distinct identity from you. This lets your business have its bank account. It can then build credit using its name.
Having your business bank account and credit card can provide numerous benefits, making various tasks more convenient and efficient…
- Keep track of your business income.
- Establishing business credit is crucial for your financial growth. First, apply for a business credit card if you meet the requirements. Then, work towards qualifying for a small business loan or a business line of credit.
- Use a business credit card to cover your business expenses. It can save you on critical purchases. These include equipment, subscriptions, a new laptop, and furniture for your home office.
- Simplify your tax season and save more. A business bank account makes it easier to report your income accurately. It also helps you claim all eligible tax deductions. Your accountant will greatly appreciate it.
- Keep exact records of your eligible business expenses. They can be deducted from your taxes.
2. It Can Improve Your Professional Image
No matter what your freelance work is, whether web design or digital marketing, Creating an LLC can boost your credibility. It shows professionalism to clients. Using a contract in your business dealings helps. So does showing a professional business card with your company’s name.
Also, Having vibrant social media accounts is a plus. Making a polished website for your freelance venture helps. It should reflect the image of a legitimate organization. These things can significantly enhance your reputation and motivate you.
3. It Separates Your Business and Personal Finances
You may be doing part-time freelance work or side hustle projects. But keeping a clear line between your business and personal finances is crucial. Creating an LLC ensures that your clients understand that you work professionally. It lets you enter into contracts using your business’s name. An LLC can protect your personal assets from legal action. It does so if your freelance work involves a costly mistake, accident, or lawsuit. It offers a “corporate shield.”
Consider exploring different options for business liability insurance. Do this in addition to forming an LLC—regardless of your type of freelance work or industry. It would help if you had business liability insurance. It safeguards you from potential worst-case scenarios in your business.
Why Being a Sole Proprietor Might Not Be Good Enough
Even without an LLC, you can freelance and make money as a sole proprietor. However, being a sole proprietor may not fit your business needs and financial goals. As a freelancer, you can’t open a separate business bank account. So, you must deposit any income into your personal bank account.
Building business credit is only possible with a proper legal entity. Keeping business and personal finances separate can be more manageable with a corporate shield. This is true if sued.
When Should a Freelancer Consider Forming an LLC?
Not every freelancer working part-time necessarily requires an LLC. You are just doing a few simple projects for loved ones and getting paid in cash. You will need to earn more from freelancing to cover the cost of filing an LLC. Or, you’re only freelancing once you get a new full-time job and won’t freelance again. Making an LLC may not be needed or worth it in these cases.
But if you want to add freelancing to your long-term plans. If you aim to maximize your business tax deductions, do so for the upcoming tax season. And if you aim to build a successful freelance business that can make an excellent full-time income. Are you looking to start a new career? One great way is to form an LLC for your freelance business.
FAQ: Why should a freelancer form an LLC?
What are the pros and cons of forming an LLC as a freelancer?
You may be among the new independent legal professionals. You may find yourself working as a freelancer or side hustle owner. In this case, you likely get 1099s from your clients. Taxes aren’t automatically deducted. You are considered a sole proprietor by default if you still need to form an LLC—your Social Security number functions as your tax ID for tax purposes. So, the critical question is: which is better for your work, a sole proprietorship or an LLC? Or are you also asking “Why should I start an LLC as a freelancer”?
There are several advantages to freelancing through an LLC:
- Asset and liability protection. It would help if you had proper protection. It guards against legal and financial issues from your work. Without precautions, you could be at risk of personal liability. This could put your assets, such as your home, in jeopardy.
- Business credit. An EIN allows you to easily open a business bank account and establish credit as a business owner.
- Professionalism. Establish yourself as a reputable professional. Do this through a good website and effective marketing. It can significantly boost your visibility and bring in more clients.
- Tax flexibility. You have the advantage of greater control as an LLC. It lets you select the tax structure that best suits your freelance business.
- Room to expand. You’ll get an Employer Identification Number (EIN) if you form an LLC. It will let you hire a team.
Drawbacks of establishing an LLC for your freelance work may include:
- Business record requirements. All businesses must keep thorough records. This is important, no matter their structure. Neglecting this duty in some businesses may result in an IRS audit. Likewise, issues arise when you merge your personal and business accounts.
- Complexity of business taxes. There are tax benefits to having an LLC instead of a sole proprietorship. But, be cautious with the added complexity to avoid issues.
- Seek assistance from a professional. Contractors and small business owners are used to taking matters into their own hands. But, it may be wise to get professional help when starting an LLC as a freelancer.
The downsides of making an LLC for your freelance business come from two things. These are poor prep and failure to keep good records. If done correctly, an LLC can offer certain advantages.
How would I benefit from having a separate business bank account?
Having a separate business bank account is smart. It keeps your personal and business assets separate by keeping your finances separate. It becomes easier to handle the money of your freelance work. This separation simplifies the process of deducting expenses and filing your business taxes.
Also, it depends on your freelance side hustle. A business bank account can be more flexible than your personal account. Take personal checking accounts as an example. They often limit how big or how often transactions can be.
Also, you may have the advantage of using business software. It can link directly to your account. This would not be possible with a shared account.
What are the tax advantages of forming an LLC if I am a freelancer?
If managed well, an LLC can give you tax breaks. It also gives access to benefits not available to non-business owners. With an LLC, you can combine different advantages. You can tailor a system that fits your business. You can choose pass-through taxation when you set up your LLC for freelancing. In this system, business taxes are “passed through” to your personal tax return. You can also choose corporate taxation.
If you opt for pass-through taxation, your earnings face taxation. They are taxed as if your business were a partnership. LLCs can choose between different tax structures. They can be taxed as a corporation or a partnership. This could lead to big tax savings. It depends on factors like household income.
Taxes are complex for many people. It’s best to seek guidance from a professional before starting an LLC. When you’re ready to file your taxes, any lawyer can connect you with a tax professional. They can provide you with affordable and convenient tax filing services. Don’t do your taxes – Get an expert to do them.
Are there intangible benefits of doing business through an LLC?
LLCs provide legal protections. They also offer tax advantages and access to a separate business bank account. There are other advantages, too. But these take more work to measure. For example, being an LLC can enhance your brand. It can help you get more prominent clients and charge higher rates. For specific individuals, this may hold less significance.
How to start an LLC as a freelancer
Setting up an LLC requires many needed steps. The steps may vary by location. However, I can offer you a comprehensive guide that will assist you in getting started. Remember to ask experts. Use online resources too. They will help you follow local regulations.
Should I start an LLC for my side hustle?
Deciding whether to form an LLC for your side hustle depends on its nature, potential liabilities, and tax situation. Consider the advantages of forming an LLC. It can shield your personal assets and bring tax benefits. Consider these when choosing a business structure. We suggest consulting with a legal professional or financial expert.
Should I start an LLC as a freelancer for tax purposes?
Starting an LLC can give you tax advantages. These include pass-through taxation and the flexibility to tax your business income. Still, forming an LLC for tax purposes is vital. It’s part of a good tax strategy. Talking to a tax specialist can give valuable guidance. They can help you find the best tax structure for your needs.
What is the best business type for a freelancer?
The ideal business model for a freelancer can vary based on personal circumstances. Many freelancers prefer to run a one-person operation. It is common because it is straightforward. However, it’s worth considering the option. You could form an LLC or another business. It can provide valuable liability protection. Consider the size, type, and future growth of your business. Use this information when choosing a business structure.
Is a freelancer a business owner?
Indeed, freelancers are recognized as entrepreneurs. They may not work in an office. But, they offer their services for payment. As a business owner, whether you’re a freelancer or not, you have to manage your finances. You must navigate contracts and make intelligent business choices.
What is the difference between starting a business and being a freelancer?
When it comes to starting a business, there are a few essential steps to take. One of the first things you’ll need to do is establish a legal entity, like an LLC or corporation. Also, you may need to hire employees. You will need to manage inventory and get physical assets. However, freelancers are typically independent professionals. They offer specialized services without forming a distinct legal entity. Both entail managing a business, but size and organization can vary greatly.
What are the key differences between an LLC and an S corporation?
Both provide limited liability. However, the two differ in taxation, management, and ownership. LLCs provide more flexibility. They allow for more adaptability in operations. S Corps have stricter requirements. But they can offer tax benefits.
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