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 will have 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 will determine 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.
Please note that, while we’ve made every attempt to ensure the information below is accurate and up-to-date, it doesn’t constitute legal advice, and it shouldn’t be considered a substitute for legal advice. Always consult with your attorney or tax expert for personalized guidance.
What’s an LLC?
LLC is one of the ways that you could legally organize and operate your business.
Here’s what you need to know:
- To form an LLC, you have to file articles of organization with your state’s business filing office. In Virginia, that would be the Virginia State Corporation Commission. Seems simple enough, right?
- Then, as an owner, you’ll be referred to as a “member,” and you’ll be able to invest money and/or services in your LLC and receive percentage ownership interests in return. Makes sense so far?
- Although an LLC can have just 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!
How does the legal status of the LLC affect you?
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, such as:
- Own property
- Be sued and sue others
- Manage bank accounts
- Borrow funds
- Hire workers
What are the Benefits of an LLC?
If you’ve been working as a full-time freelancer, making a good living and impressing clients with your skills, you might be wondering why you even have to 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 to have a formal business entity in place in order 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 that you gain from forming an LLC:
It’s simple to run your business
LLCs are easy to run. In fact, they’re actually surprisingly simple.
If you were to create a corporation, you must hold and document regular and special shareholder meetings in order to do business. Not so with an LLC.
As the name implies, a limited liability company will provide you with 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) that are 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, of course!
Basically, only your LLC’s assets and money can be taken in order to cover these costs. And that means that creditors won’t be able to touch your personal assets, such as your real estate and bank account.
Only LLC assets can be used to pay off business debts, so that means that you, the owner, would only lose the money that you’ve invested in your business. Again, your personal assets will be protected. That’s a relief!
But we should mention that, even if you were to form an LLC, you would remain 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 why 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 will be taxed the same as a sole proprietorship, a partnership, or a corporation.
- You, the single owner, decides 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 can be used when you’re a single person who owns an LLC. Because 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. 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.
Your status in the company:
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, such as expenses to cover mileage, equipment, and more.
Beyond regular business deductions, though, you might be able to take the new pass-through tax deduction, which is available to sole proprietors as well. This 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 keep up with the latest tax laws).
If you qualify for the pass-through deduction, you might be able to deduct from your income taxes up to 20% of the net income you earn from your LLC. This effectively reduces your income tax rate on your LLC profits by up to 20%. Sweet!
This is your other option if you don’t want to be taxed like a sole proprietor. If you take this route, your LLC will be taxed just like any other corporation. To be taxed in this manner, you’ll 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 business owners 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 single member 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.
A couple of quick points about sole proprietorships
A sole proprietorship is the default business entity for a one-person business.
Basically, it comes into being automatically once you start working as a freelancer and earning money. Doesn’t get much easier than that!
But a sole proprietorship isn’t a separate legal entity.
This means that you, the business owner, personally owns all of the assets, and are in charge of all of the day-to-day operations.
You report the income that you earn, as well as your losses, on your personal tax return. Then, you pay tax on any profit at your individual tax rates.
Translation: no limited liability perks. You’ll be held personally responsible for all of your business debts and any business-related lawsuits. Now that could be scary!
Some quick points about corporations
When you set up a corporation, it will be its own legal entity.
It’s formed when you file articles of incorporation with your Secretary of State, just like you’d do when forming an LLC. And, like an LLC, your corporation will have a legal existence separate from its owners, so it’ll be considered a legal “person.”
Translation: you get limited liability perks. Woohoo!
Also, a corporation is owned by its shareholders, who invest money and/or services in exchange for stock.
A corporation must also have one or more directors who are ultimately in charge. And it must have officers who run daily operations.
If you’re a one-owner business, though, you can be the single person directing and running the corporation, and you can own all of the corporate stock, too.
There’s more: you’ll work as an employee of the corporation, in addition to fulfilling your other corporate roles. As mentioned above, this differs from LLC members, who aren’t employees of their businesses for tax, unemployment insurance, workers’ compensation, or other legal purposes.
This means that a corporation could cost more than an LLC to operate if it has to pay for unemployment insurance and workers’ compensation coverage for employees.
There are two types of corporations: S Corps, which are also called small business corporations, and C Corps, 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.
Another thing to consider: 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 will pay corporate income tax on the profit, at whatever the corporate rate is, on its own return.
Then the shareholders will 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.
Another option: S Corp taxation
As a corporation, you have the option of being taxed as an S Corp instead, which is considered a pass-through entity.
This means that 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 way to go for your freelance 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 appropriate office for that state.
So, for example, if your business is located in Virginia, you should form an LLC in that state and file your articles with the Virginia State Corporation Commission.
Note: Even if you hear rumors about the advantages of forming an LLC outside of Virginia, 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 Should You Expect to Pay for an LLC?
As with other aspects of forming and operating an LLC, rules for fees can vary by state.
Virginia filing fees for forming an LLC include:
- $100 to file articles of organization with the Virginia State Corporation Commission
- $50 annual registration fee
You might also need to get other local and state business licenses and pay a fee for those. That will depend upon the type of work your LLC will be engaged in, as well as where your LLC will be located.
Also, don’t forget that there might be additional fees involved with performing a thorough LLC name search to figure out if the name you’ve chosen for your business is actually available.
- Reserving an LLC name for up to 120 days will cost $10
- A professional trademark search will cost anywhere from $30-500 for each trademark searched
Click here to read our “Freelancer’s Guide to Trademark Research” for more information.
More fees to consider – oh my!
Forming an LLC could get pricey pretty quickly.
Ultimately, how much it will cost to complete and file all of the necessary paperwork depends on who does the work.
- Will you be doing it all yourself, perhaps with the help of a book? Then you’ll 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, you could expect to pay anywhere from $500 to over $1,000.
But, wait, there’s more!
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. Ouch!
For more information, check out our Freelancer’s Guide to Registered Agents.
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 worry. Collective is here to help. Collective is the first all-in-one financial solution for self-employed people. We take care of your LLC formation, taxes, monthly bookkeeping, accounting and more.
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.