Whether delivering meals, giving rides, gigging as a contract software engineer, or working on the side, you’re operating a small business when you freelance. Even if you do not have employees or a catchy company name, you may want to consider forming a limited liability company (LLC) for your freelancing work. It is relatively simple to set up, does not require too much maintenance, and may provide some benefits for your business.
The devil is in the details as to whether an LLC is right for your freelance or contract work, so we will take a look at the pros and cons, financial benefits, tax benefits, and even some perception-based benefits of LLC formation.
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What are the pros and cons of forming an LLC as a freelancer or independent contractor?
If you work as a freelancer or contractor (i.e., you receive 1099s from your clients and taxes are not automatically deducted) and you have not formed an LLC, then you are a sole proprietor by default. For tax purposes, your Social Security number serves as your tax ID. So the more important question is which entity better fits your line of work, a sole proprietorship or an LLC.
Some of the pros of freelancing through an LLC include:
- Asset and liability protection. Without LLC protection, legal or financial trouble stemming from your work could expose you to personal liability, leaving assets such as your home vulnerable.
- Tax flexibility. You have more control as an LLC, allowing you to choose the tax structure that’s most beneficial to your freelance business (more details on taxation below).
- Professionalism. Doing business as an LLC, especially if you build a professional website and market yourself properly, can raise your profile and help you attract more clients.
- Room to expand. If you form an LLC, you can obtain an Employer Identification Number (EIN), allowing you to hire employees.
- Business credit. Your EIN also enables you to open a business bank account and start building credit as a business owner.
Cons of forming an LLC for your freelance work may include:
- Complexity of business taxes. While you can enjoy some tax savings and benefits by forming an LLC (as compared to a sole proprietorship), the added layer of complexity can cause problems if not done properly.
- Business record requirements. Even sole proprietorships should keep detailed records, but failure to do so in an LLC could invite an audit from the IRS. Similarly, problems occur if you commingle your personal and business accounts.
- Professional help needed. Freelancers are used to the DIY approach, but you may want to seek out professional assistance when you start an LLC.
As you can see, the disadvantages of forming an LLC for your freelance business primarily stem from lackluster preparation and failure to maintain adequate records. If you do it right, an LLC should provide some level of benefit.
How would I benefit from having a separate business bank account?
A business bank account separate from your personal account is a good way to prevent your assets from commingling. With separate accounts, you are better able to manage the revenue and expenses from your freelancing work. This separation makes it easier to deduct expenses and file your business taxes.
Also, depending on your freelance operation, business bank accounts may provide more flexibility than your personal account. For instance, personal checking accounts often limit the size or frequency of transactions. Additionally, you may have access to business software programs that link directly to your account (which would be impractical with a shared account).
What are the tax advantages of forming an LLC if I am a freelancer?
If properly managed, an LLC could help you reduce your tax obligations and give you access to certain benefits that are unavailable to non-business filers. Since an LLC provides significant flexibility, you can combine various benefits to structure a system suited to your business needs. When setting up your LLC for your freelancing work, you will choose either pass-through taxation (business taxes “pass through” to your personal tax return) or corporate taxation.
If you choose pass-through taxation, your wages (typically all revenue collected by a freelancer) are taxed as if your business was a partnership. Since LLCs can mix and match tax structures, it is possible to be taxed as either a corporation or a partnership. Depending on other factors (such as overall household income, etc.), this could result in significant tax savings.
Taxes do not come easy to most people, so consult an accountant or talk to a lawyer before you form an LLC.
Are there intangible benefits of doing business through an LLC?
Aside from liability, tax benefits, and business bank account eligibility, LLCs offer a few benefits that are difficult to quantify. For instance, branding that comes from working as an LLC could help you land larger clients or fetch higher rates. For some, this may not matter as much.
Form an LLC without the guesswork
Every business owner knows proper preparation and planning are the keys to success. If you are a freelancer or contract worker, there may be good reasons to turn your one-person operation into an LLC for your freelancing work. But look before you leap so that you make the right choice and get the most out of your efforts. If you have questions about business formation, don’t hesitate to speak with an attorney.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.