Are you a freelancer who’s ready to officially form their own business? That’s great! Just keep in mind that there are several steps involved, one of which is to decide how you’ll legally organize your business.
Why is this such a big deal? Well, your choice has a big impact on how you’ll be treated by government agencies and how you’ll be taxed. Plus, the way you organize your business determines if you’ll be held personally liable for your company’s debts.
Because there isn’t a one-size-fits-all option when it comes to choosing a business entity, you might not know where to begin. But one of the most popular choices, particularly for freelancers, is the limited liability company (a.k.a. LLC).
Here’s a bit of information on LLCs, including the benefits of organizing your freelance business as an LLC.
What’s an LLC?
An LLC is one of the ways that you can legally organize and operate your business.
To form an LLC, you file articles of organization with your state’s business filing office. In California, that would be the Secretary of State. Then, as an owner, you’ll be referred to as a “member,” and be able to invest money and/or services in your LLC in exchange for a percentage of ownership
Although an LLC can have one member or several members, if you’re a freelancer who’s running a one-person business, you’ll be a single-member LLC (also known as an SMLLC). Once it’s legally formed your LLC will be its own entity, with an existence separate from your own. Kind of like giving birth to your own LLC baby.
Here are the basics: your LLC will be considered its own legal “person,” which means it can do pretty much anything that an actual person would be able to do, like:
- Own property
- Be sued and sue others
- Manage bank accounts
- Borrow funds
- Hire workers
Why form an LLC?
If you’ve been working as a full-time freelancer, you might be wondering why you should even bother forming an LLC, or any other formal business entity, for that matter. After all, you’ve already figured out that you don’t need a formal business entity to start and run a freelance business.
Before you decide to keep freelancing on your own, though, here are a few of the many perks of forming an LLC:
It’s Simple to Run Your Business
LLCs are easy to run. In fact, they’re surprisingly simple.
If you were to create a corporation, you must hold and document regular and special shareholder meetings in order to do business. This isn’t required with an LLC.
As the name implies, a limited liability company provides you with, you guessed it, limited liability.
This means that you won’t be held personally responsible for paying:
- LLC business debts that you haven’t personally guaranteed, including most routine bills for supplies and equipment.
- Injuries (not covered adequately by insurance) suffered by people who are hurt by your LLC’s business activities.
Who’s going to pay for these business debts and injuries? Well, your LLC.
Basically, only your LLC’s assets and money can be taken to cover these costs. And that also means that creditors can’t touch your personal assets,like your real estate and bank account. Only LLC assets can be used to pay off business debts., You, the owner, only stand to lose the money that you’ve invested in your business. Again, your personal assets are protected.
But, we should mention that even if you were to form an LLC, you are still personally responsible for your own wrongdoing, such as professional malpractice or fraud. So keep that liability insurance policy, just in case.
Sure, protecting your personal assets by separating them legally from your business’s assets is one of the main reasons so many freelancers choose to form an LLC. But beyond that an LLC is also great come tax season.
Here’s what you need to know about taxes and LLCs:
LLCs aren’t recognized by the IRS for tax purposes. Single-member LLCs are referred to as “disregarded entities.”
LLCs are taxed the same way as a sole proprietorship, a partnership, or a corporation. You, the single owner, decide how you want to be taxed and that gives you a lot of flexibility. So, whether you want to be taxed like a sole proprietorship or a corporation is up to you.
Sole Proprietor Taxation
This is the default tax treatment for single-member LLCs, it’s also the most commonly used.
If you’re a freelancer who owns a single-member LLC and you choose to be taxed as a sole proprietor, you’ll file Schedule C, Profit or Loss from Business, when you file your tax return. Yep, it’s the same form you’ve been using as a freelancer all along.
Just list all of your business income and deductible expenses. Then, you’ll pay income tax at your individual tax rates on any profit your business earns. Pretty straightforward, especially when it comes to paying taxes while running a business.
Another reason why sole proprietor taxation is popular is because you aren’t considered an employee of your LLC. Rather, you’re the self-employed business owner.
This means that your LLC doesn’t have to cover payroll taxes on your income or withhold income tax or Social Security or Medicare tax from your LLC’s profits. But you do have to pay income taxes and self-employment taxes (Social Security and Medicare taxes) on your LLC’s net income.
Filling out a Schedule C means you’re entitled to the same tax deductions as any other business.
This includes expenses to cover mileage, equipment, and more.
Beyond regular business deductions, you might be able to take the new pass-through tax deduction, which is also available to sole proprietors. This deduction went into effect in 2018, and it’s set to last through 2025 (as of the time of this writing. Things could change, so it’s best to stay abreast of the latest tax laws).
If you qualify for the deduction, you could deduct up to 20% of the net income you earn from your LLC from your income taxes. This effectively reduces your income tax rate on your LLC profits by up to 20%.
If you don’t want to be taxed like a sole proprietor anymore this is your other option. If you take this route, your LLC will be taxed just like any other corporation.
To be taxed in this way, you need to file a document known as an “election” with the IRS. Elect to have your LLC taxed like a regular C Corp or S Corp.
Is corporate taxation common amongst freelancers? Truth be told, not really, especially when it comes to single-member LLCs. But, because the corporate tax rate is lower than it used to be (and, again, that could always change in the future), more businesses might choose to take this route.
Comparing LLCs to Other Types of Businesses
If you still aren’t sure about whether an LLC is right for your freelance business, you also have the option of operating as a sole proprietor or a corporation.
Weighing the pros and cons of each of these options will help steer you in the direction that’s best for you.
Sole Proprietorship vs Corporation
There Are Two Types of Corporations:
1. C corporations, or regular corporations
When you form a corporation, it automatically becomes a C corp for federal tax purposes. This is the only type of business that isn’t a pass-through entity. Instead, it’s taxed separately from its owners.
A C corp has to pay income taxes on net income and file its own tax returns with the IRS. It also has its own income tax rate. Also, C corps are subject to double taxation. Any direct payment of profits to shareholders is considered a dividend by the IRS and taxed twice.
First, the corporation pays corporate income tax on the profit, at whatever the corporate rate is, on its own return. Then, the shareholders pay personal income tax on the money they receive, at the capital gains rate (higher income shareholders might even have to pay an additional Medicare tax).
All of this could add up to more than the tax an LLC member would pay on the same amount of profits. But, you could avoid double taxation by paying all profits to employee-shareholders in the form of salary, benefits, and bonuses.
2. S Corp, which are also called small business corporations
As a corporation, you have the option of being taxed as an S Corp instead.
This is considered a pass-through entity. Corporate income or losses are passed directly to shareholders, who then divide taxable profit according to their shares of stock ownership. Shareholders then report that income on individual tax returns, thereby avoiding double taxation.
Where to form your LLC
After weighing the pros and cons of sole proprietorships, LLCs, and corporations, you may have decided that, yes, an LLC is the best option for your business.
Now the question is, where will you form it? That’s entirely up to you! But don’t take this lightly. It’s an important choice because the state of formation’s laws will govern your LLC. Choose the state where you want to set up your business, and file articles of organization with the Secretary of State. So, for example, if your business is located in California, you should form an LLC in that state.
Note: Even if you hear rumors about the advantages of forming an LLC outside of California, keep in mind that most of those benefits aren’t all they’re cracked up to be, especially if you’re a single-member LLC. In the end, if you were to form your LLC in another state, it will likely cost you more money because you’ll have to pay two filing fees.
How Much Does it Cost to Form an LLC?
California filing fees for forming an LLC include:
- $70 to file articles of organization with the California Secretary of State’s office
- $20 to file a Statement of Information, Form LLC-12, with the California Secretary of State (this must be filed every two years)
You might also need to get other local and state business licenses and pay a fee for those. Which licenses you get will depend on the type of work your LLC is engaged in and where your LLC is located.
There might be additional fees involved with performing a thorough LLC name search. A name search is used to figure out if the name you’ve chosen for your business is actually available.
- Reserving an LLC name for up to 60 days will cost $10
- A professional trademark search will cost anywhere from $30-500 for each trademark searched
Click here to read our DIY Guide to Trademark Research for more information.
Click here for The Ultimate Guide to Naming an LLC in California.
Forming an LLC could get pricey pretty quickly. Ultimately, how much it will cost depends on who does the work.
- Will you be doing it all yourself, perhaps with the help of a book? Then you’ll need to pay the legal costs of your state and invest a lot of time and effort into the process.
- If you end up using an online LLC formation service, you could pay up to $300. If you hire an attorney, expect to pay anywhere from $500 to over $1,000.
- You’ll also need to designate someone to accept legal papers for your LLC. And, while you can take a DIY approach, it’s best to use a professional registered agent. How much will that cost? About $75-150 annually.
- All LLCs that do business in California have to pay an annual minimum franchise tax which is a whopping $800! If you earn over $250,000 annually, though, you’ll pay an additional fee that’s based on your total annual income. That could range from $900-12,000.
Is There a Smarter, More Affordable Way to Form Your LLC?
By now, your head might be spinning with everything you’ve discovered about LLC forms, fees, and taxes.
But, don’t stress. Collective has created a system that makes it simple and affordable to form and maintain your LLC. We help you:
- Search through databases to ensure you’ve found the perfect name for your business.
- Save time by filling all of the appropriate forms to set up your LLC legally.
- With everything from getting necessary business licenses to getting your EIN.
We know it’s hard to get started, so we’ve set up a method that lets you focus on running your business every day. Let us help you get started so you can take your business to new heights.
Stephen has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for small businesses, entrepreneurs, independent contractors, and freelancers. He is the author of over 20 books and hundreds of articles and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. Among his books are Deduct It! Lower Your Small Business Taxes, Working with Independent Contractors, and Working for Yourself: Law and Taxes for Independent Contractors, Freelancers & Consultants.