When you're a freelancer, you're also running a small business. Being self-employed inevitably makes tax season complicated. That's why many freelancers have chosen to establish their own businesses legally.
There are three types of business structures most freelancers register under: sole proprietor, LLC and S corp. There are advantages and disadvantages to all, such as better tax breaks or filing a separate tax return. Each situation allows you to deduct for business costs, such as internet or travel.
Why create a legal business?
Although many professionals who freelance on the side simply report their earnings as "miscellaneous income" via the Schedule C (1040) form on their personal tax return, full-time self-employed individuals may find it beneficial to create a legal business entity.
Lauren Saccone, freelance writer and social media consultant, recently established an LLC called Pitchbow at the end of 2016. After freelancing part-time for nearly a decade, she has been a full-time freelancer based in New Jersey for the past two years.
Saccone's tipping point was filing her taxes for 2015.
"I didn't know anything about filing as a freelancer," she said. "I had to figure it all out myself at the last minute, and it was an informative experience, but (it was) stressful." [See related story: Self-Employed? Everything You Need to Know About Taxes]
Sole proprietorship is one of the most straightforward types of business classifications. It's also the most common and simplest, because it doesn't require formal action. If you're already a freelance writer, like myself, you're already a sole proprietor of your own business. This makes it easy to prepare for tax season.
There are a few important drawbacks freelancers should be aware of. According to the Small Business Administration, there is an unlimited amount of personal liability. If a company wants to take legal action against your work, they can legally take action against you specifically. You're also held personally responsible for business-related debts and financial burdens.
Limited liability company (LLC)
Since Saccone offers social media services and isn't exclusively writing for publications, the LLC structure was the best choice for her. LegalZoom, an online legal service for business owners, helped her find the best fit and guided her through all the difficult paperwork.
Another reason she chose LLC was legal safety, which sole proprietorship specifically doesn't provide.
"If I wrote something someone didn't like, they would previously go after me personally, but now, it'd be through my business," Saccone said. "It provides a security net.
For instance, late payments are always a nightmare for freelancers. Under an established name and company, Saccone feels more confident chasing down payments than she did before. Pitchbow provides her an added blanket of agency.
Saccone previously considered sole proprietorship, but the category wasn't inclusive of her overall services. An LLC encompasses her business's wide range of services.
"One day, I'll be pitching stories, another I'm writing Instagram posts, and the next I'm working on content marketing," Saccone said.
LegalZoom explains that an LLC, as opposed to a sole proprietorship, allows business owners to raise money, not take personal responsibility for a company's debt and easily transfer ownership. An LLC requires more paperwork and costs more, but both types of businesses are taxed similarly. Although Saccone doesn't employ anyone but herself, as her workload continues to grow, she's optimistic about the possibilities her business's legal structure allows.
Of course, self-employment taxes are a huge drawback. The Small Business Administration also mentions the limited lifespan of an LLC, which is contingent upon its members. If someone leaves, the business is dissolved.
What about S corporations? Freelancers Union reports that an S corp helps you dodge paying both personal and corporate taxes. S corps have much stricter guidelines for taxes, though, because owners are paid based on salary and receive dividends from any additional profits the business may earn. Rather than filing a personal tax return, you must file a specific business return.
S corps also require business owners to pay their partners fairly. The Small Business Administration points out shareholders must receive adequate compensation. Otherwise, the IRS can flag you for unfair salary distribution.
If all this seems daunting to you, just remember that your freelance business can still be legitimate without the legal structure, especially if you're just starting out.
"I don't think it's necessary to be an LLC, S corp or sole proprietor to be a successful freelancer, but it's really helpful," Saccone said.