Although Wyoming was technically the first state to introduce the Limited Liability Company (LLC) in 1977, the LLC didn’t take off as a popular business model until the 1990s. While it isn’t possible to know exactly how many freelancers have formally organized LLCs to protect their interests, IRS statistics and the continually growing freelancer economy suggest that more and more freelancers are forming LLCs.
Given the benefits an LLC can provide you as a freelancer, and the minimal resources required to setup and maintain an LLC, there are some very good reasons to consider the LLC model from your freelancing business.
LLCs Protect Your Personal Assets
The name itself describes the LLC’s biggest advantage to you, as a freelancer. LLCs limit your personal liability. Here’s why this is so important.
When you began freelancing without any formal business structure in place, the government treats your business as an extension of yourself. That means that you are fully responsible for paying your freelance business taxes on your personal tax return. This is the easiest way to get going, but you do open yourself up to risk.
If, for example, you run into any legal trouble, your personal property is at risk. This includes (but is certainly not limited to) personal and jointly-owned assets like:
- Your car
- Your home, or other real estate
- An investment portfolio
To reiterate, these assets are at risk even though they are not associated with your freelance activity.
An LLC puts up a wall of protection between your personal assets and any liability your freelancing business might face. Generally speaking, LLCs offer the same level of protection for company owners as the more traditional corporation model. However, the requirements of setting up and maintaining an LLC don’t come close to those required in a corporation.
LLCs Are Simple to Setup and Inexpensive to Maintain
The biggest deterrent for a freelancer—or any business owner for that matter—to formally set up a corporation is the cost and operational burden. Corporations are expensive. They require initial and quarterly filings with the government. They require board and shareholder meetings. They trigger both corporate taxes, and payout level taxes. They require record keeping, company minutes, bylaws—the list goes on.
Setting up a corporation for a single freelancer seems difficult to justify. But here’s where an LLC makes perfect sense: When you form your LLC, you file your Articles of Organization (or your state’s equivalent) with the government—and that’s about it.
The fee to submit your Articles of Organization is nominal. It differs by state, but as an example, it’s currently 0 in South Carolina. You will most likely create an Operating Agreement to set the basic rules for how your freelancing business will be governed: things like distribution rules, voting rights and new owners. In many states, however, you don’t actually have to file it.
Corporations have a reputation for being expensive (and rightly so). LLCs offer many of the same benefits at a much lower cost.
Learn more about how to form an LLC on Incorporate.com.
LLCs Offer Flexible Tax Benefits
Since the LLC has been in existence for quite some time, you may be familiar with its personal protection, low cost and ease of operation. While these are great benefits to you as a freelancer, they don’t do the LLC the justice it deserves. The LLC’s flexibility allows you to mix and match benefits from various business forms into a custom bundle that best suits your needs. And a good example of flexibility is tax treatment.
When you initially set up your LLC, you will elect one of two forms of taxation:
- Pass through taxation: Your freelance business earnings will be taxed like a partnership. In other words, the business itself won’t pay any taxes. Rather, the taxes are “passed through” to you as the business owner and paid on your personal tax return.
- Corporate taxation: Sometimes referred to as double taxation, your freelance business will pay the corporate tax rate, but you will also personally pay taxes on any wages or distributions made to you as an employee and/or owner of the LLC.
LLCs actually allow you to mix corporate and partnership tax structures to take advantage of perks from both models. For instance, assuming your business meets all the requirements for S-Corp status—if you are a single-member, freelancer business, you most likely meet this—you can actually elect to be taxed as a corporation, and then an S-Corporation. This provides a tax-beneficial mix of corporate and partnership tax.
In the end, you bypass the initial corporate tax, but only pay capital gains rates on the pass through tax at the personal level. This tax structure arrives while still only having to meet the LLC requirements from a reporting standpoint—a perfect mix of ease and tax beneficial treatment.
A Word of Caution on LLCs
Sold on the LLC model for your freelancing business?
Great! But, as with any good thing, there are some traps for the unwary. While LLC rules are generally broad and flexible, the number one place to misstep is with taxes. As mentioned above, you have the flexibility to mix corporate and partnership tax models within an LLC structure. However, the IRS does require that you report correctly, using the correct forms. This topic deserves an entire post on its own, but the guiding principle is know the tax structure you have elected, and pay your taxes accordingly. If you have any doubt, seek expert advice.