Freelancers make up a significant portion of the American workforce. In 2019, some 57 million people were freelancing in the U.S. Since the Coronavirus pandemic hit in early 2020, those numbers have only continued to rise. According to Upwork, freelancing is up nearly 22% since the start of the pandemic, contributing upwards of $1.2 trillion to the U.S. economy.
With the "gig economy" growing every day, many new freelancers find themselves wondering about things they didn't have to worry about as a traditional W-2 employee, such as self-employment taxes. While some freelancers choose to operate as a sole proprietorship without ever formalizing their business, others find it advantageous to make the switch to an LLC or an S-Corporation.
If you are a freelancer asking if you should form an LLC, we can help. Keep reading to discover the benefits of starting an LLC as a freelancer and if making the change is right for you.
What Is a Freelancer?
Freelancer is a term that is applied broadly to self-employed and contract workers. Although a freelancer may perform work for a company, they are not considered an employee. Some common traits that freelancers share may include:
- Not employees
- Keep their own hours
- Bill for their time or by the project
- Not committed to any single job long-term
- Often work for multiple companies, organizations, or individuals at a time
- Pay their own employment and business taxes
What Is an LLC?
By default, individuals who begin work as a freelancer are considered a sole proprietorship. Whether you realize it or not, this is the business entity you are operating under as far as Uncle Sam and your taxes are concerned.
LLC is short for a limited liability company and is a form of business specific to the United States. To be considered an LLC, a freelancer must legally form a new business entity within their state of operation. This business entity is unique because it can combine pass-through taxation with the limited liability of a corporation. For many freelancers, an LLC also offers incentives to limit their yearly payroll taxes, add investors, and increase their trust among clients.
I'm Already a Business, Is the Switch To an LLC Worth It?
Choosing how and when you do business is one of the hallmarks of entrepreneurship. Being able to operate your business your way is one of the main reasons people love freelancing. Deciding to switch from a sole proprietorship to an LLC is a choice many freelancers struggle with, ultimately depending on the individual and their current circumstances. To help make the right choice, we've listed some essential questions every freelancer should ask themselves before forming an LLC.
Can I Afford To Be Personally Liable if Something Goes Wrong With My Work?
If you can't afford to risk losing your personal savings or property as the result of a legal case against your business, forming an LLC is essential. As the name suggests, an LLC limits your personal liability as a business owner. This is vital if you ever run into legal trouble regarding your work.
If a client is not happy with your work or claims a financial loss because of your business, they can take you to court. If you haven't established an LLC, you may be personally liable to pay any potential settlement with your personal assets, including:
- Your car
- Your home
- Your money
- Your savings and retirement accounts
When you form an LLC and operate as that business entity, you will have a wall of protection placed around your personal assets. As long as you operate legally and professionally, only your business's assets will be considered as payment if a judgment is passed against your company.
Am I Paying too Much in Taxes?
How you pay taxes is a significant change for freelancers coming from a more traditional W-2 employment background. At the federal level, freelancers are required to claim any applicable earnings on their taxes to be paid at their personal tax rate. Forming an LLC offers freelancers more flexibility in how they file and pay their taxes. When setting up the LLC, you will have two options for your taxes.
Option 1: Pass-Through Taxation:
With pass-through taxation, the business won't pay any taxes. Instead, any income is passed through to the owner, who will be responsible for paying taxes on that money on their personal tax return. Freelancers receiving this type of pass-through income may qualify for a 20% deduction on their taxable business income, further decreasing their total taxable income.
Option 2: Corporate Taxation:
Choosing this option will require your business to pay corporate taxes, and employees or owners will also be responsible for paying taxes on any wages or distributions paid out.
With an LLC, qualifying freelancers may also be able to mix tax structures. This allows freelancers to potentially bypass corporate taxes and only pay capital gains tax on any pass-through income. To determine your potential tax savings, consult with a professional tax accountant, lawyer, or consultant.
Do I Have Extra Time to Dedicate to My Business?
While the time and paperwork required to run an LLC is less than a traditional corporation, there may still be some required record keeping depending on your state of incorporation. Likewise, you will need to set up separate bank accounts when operating as an LLC and apply for an Employee Identification Number (EIN). Some additional time requirements you may need to consider as an LLC include performing the following duties:
- Filing formation documents with your Secretary of State's office
- Maintaining operating agreements and amendments, including:
- Capital contributions
- Profits and losses
- Voting rights
- Recording member and management information
- Keeping meeting minutes
- Filing and storing tax returns
- Keeping employment tax records
- Managing other financial records and contracts
For specific annual meeting or filing requirements for your LLC, you will need to work closely with your state of incorporation.
Am I Willing to Pay Some Minimal Start-up Costs & Annual Fees?
While the costs of forming an LLC can be minimal, especially compared to more complicated business structures, it will require some start-up costs and ongoing fees. These costs may include:
- State LLC filing fees
- Ongoing LLC fees
- State name reservation application
- Doing business as (DBA) application (if operating under another name)
- Business licenses (if required by your state)
- License renewal fees (if applicable)
- Annual taxes
- Annual report fees (every one or two years in most states)
- Registered agent fees
When Is the Right Time to Switch to an LLC?
Forming an LLC may not be right for everyone. However, many freelancers who make the switch could limit their personal liability and pay less in taxes. To determine if you are ready to form your LLC, carefully consider your business's legal and financial implications. For many freelancers, when their net income exceeds $30,000 annually, the advantages of making the switch begin to outweigh the upfront and ongoing fees that an LLC might require.
A Simpler Way to Form an LLC
If you are ready to make the switch to an LLC for your freelancing business but don't have the time required to start, Swift Filings can help. We've made forming an LLC simple for small business owners and can help you file online in as few as 10 minutes. We'll explain the different business entities available to you and the advantages of each to make sure you are maximizing your tax and legal benefits. To get started, try out our Incorporation Wizard.