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What Business Structure Should I Choose as a Freelancer?

by Ryan Battles in Business Tips

Whether you're just getting started with freelancing and are wondering how to make things "official," or if you are considering restructuring your business for greater tax savings, being familiar with the business structures available to freelancers can make a huge difference in mitigating liability and saving money.

Laws vary from state to state when it comes to setting up certain types of businesses, so while this article will give an overview of options available, it will be helpful to follow up with either a Google search on "How to form an [x] in [my state]," or visit a site like Rocket Lawyer where they can guide you through the steps online specific to your state. And as always, we recommend consulting with your own professional accountant and/or tax advisor when making these types of decisions.

Sole Proprietorship

If you haven't registered any other type of business entity, but are making some money as a solo freelancer, you are operating as a sole proprietor. You don't need to do anything official to operate as a sole proprietor. Simply declare your business income as miscellaneous income on your annual tax return. To the government, this makes you a "pass through entity" where basically any income to the business is simply passed through to you personally. Note: it can be easy to forget the tax liability that is awaiting you for all of that income since nothing is taken out automatically like a paycheck would. Talk with an accountant about how much money you plan to make in your business and they can help you formulate a plan to save a specific amount from each client payment for tax time.

While it is the easiest form of business to set up and operate, your personal assets are held liable when you operate as a sole proprietor. For example, if a client sues you while operating as a sole proprietor, they may be able to go after the money you have in savings or your real estate. 

Fortunately, there is another type of business entity that can protect your assets, and it doesn't require much more work than operating as a sole proprietor.

Limited Liability Company

Setting up a Limited Liability Company (LLC) requires a few more steps, some of which carry a fee. However, you can still be taxed as a pass-through entity (declare income simply as personal income on your tax return), but legally you are only liable for the assets directly related to the company. 

To form an LLC where I live in Ohio, these are the steps that I took:

  1. Searched for my desired company name within the State of Ohio's website to ensure I had a unique name in the type of business I was running (free).
  2. Filed initial articles of incorporation online at Ohio Business Central ($99).
  3. Applied for a federal EIN online (free).
  4. Purchased a short stack of business cards with my business name and title.
  5. Set up a business checking account at my local bank using my EIN and business name.

Those last two steps are not required to form an LLC in Ohio, but they are helpful in establishing a separate business entity that provides legal protection in the event of litigation.

Note: Ohio is one of the most relaxed states when it comes to an LLC. Some states require more paperwork such as articles of organization, or a recurring fee. Be sure to check with your local requirements for forming an LLC.

S Corporation

Once your business begins making a significant amount of money (like more than you would make as an employee doing what you do), then it might make sense to form an S corporation. An S corporation is a lighter version of the C corporation that larger businesses are usually operating as. With an S corporation, you pay yourself a reasonable salary out of your businesses profits, then the rest of the business profit can be paid out to you as a dividend, at a lower tax rate. The complexities of how this is done will require the assistance of an accountant, and you will now be required to file quarterly payroll taxes. 

While there are tax savings that come with an S Corporation, the additional paperwork and overhead for an accountant may offset the tax benefits. Typically, if you are working with an accountant as an LLC, they will let you know whether or not an S corporation will make sense in your situation. 

Conclusion

If you are just starting out with a few low-risk projects as a freelancer and want the least amount of setup possible to begin operating your business, then a sole proprietorship makes a lot of sense. For a little more time and money, forming an LLC will position you in a more professional manner and protect your personal assets. This tends to make the most sense for a majority of freelancers. Of course, when business is really taking off and you would like to lower your tax liability, an S corp might make sense as long as the additional time and fees associated net a more profitable scenario than the LLC. 

Disclaimer: Harpoon and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.

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