The number of freelancers in the U.S. is on the rise, topping 70 million and growing. Freelancers work in all sorts of fields, from writing to graphic design and even accounting.
If you’re freelancing and have not created a business entity, you may or may not know that you’re operating as a sole proprietorship. What you also may not know is that forming a limited liability company (LLC) for your freelance business has many benefits and could be a good option for you.
Here we will detail the advantages that an LLC can provide to freelancers so that you can decide if it’s a good option for you.
What Is an LLC?
An LLC is a type of business entity that you’ll register with your state. An LLC is simple to form and requires filing a document that’s called the articles of organization in most states. Generally, you can file the form online with the Secretary of State’s office or whatever agency in your state that handles business registrations.
An LLC, as its name implies, offers liability protection for owners, called members, and many other benefits.
What Is a Sole Proprietorship?
A sole proprietorship is what your business is by default if you do not register an entity with the state and you’re the sole owner of the business. There are no documents to file with the state, and the business itself does not file tax returns.
Three Advantages of an LLC for Freelancers
There are three key benefits that an LLC offers that make it a good option for freelancers.
Tax Flexibility of an LLC
If you’re operating as a sole proprietorship, you and the business are one and the same. Your freelancing income is reported on your personal tax return and taxed at your personal income tax rate.
However, you’re also responsible for paying self-employment taxes on your income. The self-employment tax rate is 15.3% as of 2022, so that can be a heavy chunk of money.
If you form an LLC and you’re the only owner, which is called a member in an LLC, by default you’re taxed as a sole proprietorship. In a single-member LLC, the income passes through to you, the member, to be reported on your personal tax return. The LLC itself is not taxed.
You’re still responsible for self-employment taxes in this situation.
However, you can elect to have your LLC taxed as a corporation, and corporation shareholders are not subject to self-employment taxes. This is the reason that many LLC members elect a corporate tax status.
When you have a corporation tax status, which can be an S-Corporation or a C-Corporation, your business becomes a bit more complicated to run, and you’ll have additional expenses. This means that electing a corporation tax status is only beneficial if the self-employment tax savings is greater than the added costs of a corporation status.
It’s a decision that you should make with the help of your tax advisor.
The point is, forming an LLC gives you a choice and could result in significant tax savings.
Personal Liability Protection
With a sole proprietorship, you and the business are considered one and the same. This means that the obligations of the business are your obligations, so if your business cannot pay its debts or is sued, you are personally liable. This puts your personal assets at risk.
An LLC, on the other hand, is its own entity, separate from you, the member. The LLC can have its own assets and debts and is solely responsible for the obligations of the business. You therefore are not personally liable for debts that the LLC cannot pay, or if your LLC is sued. Your personal assets are thus protected.
This is generally the main reason that many entrepreneurs, including freelancers, choose to form an LLC. You may not think that you’ll ever be in a situation where your business cannot pay its debts or is sued, but even as a freelancer, you run the risk of being party to a lawsuit for errors in your work or for other events.
As a sole proprietorship, again, you and the business are one and the same. By forming an LLC, you may give clients a more professional impression. You’ll seem like a “real” company, so to speak, and appear to be more serious about your business.
It seems like a small thing, but perception can have a real impact on your credibility.
How to Form an LLC
Several steps are necessary to form your LLC.
Select a Registered Agent
A registered agent is a person or company authorized to accept official correspondence on behalf of your business and is required in almost all states. You can be your own registered agent, or you can appoint another individual or utilize a registered agent service.
When you officially file your LLC paperwork with the state, you’ll simply fill in the registered agent’s information on the document.
Select a Management Structure
Presumably, as a freelancer, you’ll be managing your business yourself, which will make you a member-managed LLC.
If you hire someone to manage your business, you’ll become a manager-managed LLC.
Some states require that you state your management structure on your articles of organization.
File Documents with the State
Again, forming your LLC requires registration with your state which is done by filing articles of organization, which in some states is called a certificate of organization or a certificate of formation.
In most states you can file online on the Secretary of State’s website. There is a fee to file which varies by state and can range from $40 to $500.
Draft an Operating Agreement
An operating agreement is only required in a handful of states, but it’s an important document, particularly if your LLC has more than one member or if you may add a member in the future.
An operating agreement defines ownership percentages, how profits and losses are allocated, what happens if something happens to a member, roles and responsibilities of members and managers, and more.
It’s highly recommended that you have an attorney draft your operating agreement so that the interests of the LLC and the members are protected.
Select Your Tax Status
As explained previously, you can choose the tax status of your LLC, which you should do with the advice of your tax advisor.
If you choose a corporation status, you’ll simply file an election form with the IRS.
Obtain an EIN
An employer identification number (EIN) is required if your LLC has more than one member or if you have employees. It’s used by the IRS to identify your business and for tax reporting purposes.
You can easily apply for an EIN on the IRS website.
A few tasks remain after you complete the initial steps which are:
- Obtain business insurance
- Open a business bank account
- Check with your local governments for business license and permit requirements
- Check your state’s LLC annual report requirements
An LLC offers several benefits for freelancers, most notably personal liability protection, so it’s worth considering. If you’re in doubt, consult with your attorney and tax advisor about the right choice for you. The type of business entity you choose can impact the success of your freelancing company.
Author: Carolyn Young
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