Incorporating as a Freelancer: The Questions You Need to Ask
Most freelancers automatically set up business as sole proprietors. In most countries, running a sole proprietorship is as simple as hanging out your shingle — the government only cares whether you pay your taxes on time. Just because operating as a sole proprietor — also known as a sole trader in some parts of the world — is the easiest option, however, doesn’t mean that it’s the best. For some freelancers, making the switch to a corporation or another business structure can offer some benefits.
If you just automatically moved into running your freelance business as a sole proprietor, there are a couple of questions worth asking yourself. Depending on the answers you may find that incorporation makes sense for your business.
Can incorporation decrease your taxes?
One of the biggest questions you have to consider before incorporating is just how your business structure affects your taxes. There are multiple types of corporations, many of which can offer tax benefits. For instance, a freelancer who incorporates as a C corporation can deduct health insurance premiums as a business expense — avoiding paying income tax on the money used to pay those premiums. Because the question of taxes is one of the main reasons that freelancers choose to incorporate, it’s worth discussing your options with your accountant or tax professional — he or she can help you find a business structure that minimizes taxes.
Another added benefit is that incorporation can reduce your chances of being audited: in 2006, the IRS audited 3.8 percent of sole proprietors. The number of audits for corporations was significantly less: only 0.8 percent of C corporations were audited.
Can incorporation decrease your liability?
Most freelancers don’t think about liability until the question comes up, like when a client asks to see your certificate of liability insurance. But liability can be just as much an issue for freelancers as for other business owners. A freelance photographer may do a shoot on location where someone gets hurt. A freelance writer may provide content that gets a client sued. No one wants such a situation to occur — but minimizing your liability in the event that something happens is important. Incorporation can help minimize a freelancer’s personal liability and may even make it easier to find liability insurance.
How much is incorporation going to cost?
There’s always a one time cost associated with incorporating. It’s usually a few hundred dollars, depending on the fees of the particular state you’re incorporating in. But there are a few costs worth noting before you start incorporating: while it offers a lot of protection, running a corporation is more expensive than running a sole proprietorship.
One of the costs associated with corporations is tax preparation — corporate taxes are more complicated, and can cost as much as $1,000 to have a professional prepare. That expense is entirely deductible as a business expense, but may not be practical for all freelancers. To get a clearer picture of your costs as a corporation, you may need to check with your accountant on what you might expect to pay in fees. In most cases, you’ll probably hear a number significantly lower than $1,000, but it’s still worthwhile to have a good idea before moving forward with incorporation.
Finding More Information
If you’re freelancing in the U.S, your first stop to learn more about incorporation should be the Small Business Administration. The site offers further information on the incorporation process. While the paperwork to incorporate in most states can be handled by a lay person, it can be worth consulting with a lawyer to make sure that you get everything right. There are also a number of companies that will walk you through setting up incorporation. MyCorporation (run by Intuit) is actually providing free help with incorporation right now — although you’ll still be responsible for the fees associated with filing your articles of incorporation in your home state.
A good starting point for Australian freelancers is business.gov.au. The site offers guides to business structure options, as well as links to information about business structures in specific states and territories. For U.K.-based freelancers, business structure information is available through Business Link. The site offers information on the specifics of choosing a structure, as well as pointers on how to get started.
No matter what country you’re freelancing in, it’s worthwhile to check over your business structure options with your tax professional — if you’ll need a little legal help, your tax professional can typically point you in the right direction.
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HI Thursday,
For comparison info: my LLC in Michigan cost $50 (it’s one piece of paper), and my taxes were just done by my regular accountant, who charged $200.
Good article!
I’ve had my sole proprietorship for about ten years, since I had a regular job and was doing some freelancing on the side. Things changed for me in October, when I started doing freelancing full time. That’s when I incorporated. In Canada, we have the option of a Provincial and/or Federal incorporation. So I opted for a federal incorporation. I haven’t done my taxes yet, so I can’t tell you what is the advantage. But what I’ve found interesting is that the banks look at you differently, when you are incorporated. Knowing what I know now, I would have incorporated a long time ago.
To follow up with Allena’s comparison, I just started an LLC which cost $60 (in Connecticut). I havn’t had to do taxes yet, but I plan to do them myself using TurboTax or Quicken for small businesses.
Texas is the most expensive state in which to set up a charter. I chartered my company (LLC) for the going rate of $300. But the tax benefits are worth it especially if you own a significant amount of personalty or realty. I didn’t set myself up as an LLC until after we purchased our house two years ago. Because the entire converted attic (27% of the entire square footage of the house) is my office, I can offset some of my mortgage and monthy utilities, and the tax savings is tremendous. (Next, a big paddy wagon will pull up in front of my house and tote me off to the federal pokey for tax fraud?!?) I have been dotting my “i”s and crossing my “t”s for two years now and I feel confident that I’m on the right track.
This doesn’t even begin to touch on the tangible reward of incorporating or chartering your business. For some reason, I began to take my business more seriously once I’d invested that $300 and was a “real” company. That may be just the thing you need to get yourself in gear and grow your business.
Great Article, Thursday!!
I like thursday’s articles…they’re exactly what I need right now…and very related the the not so fun parts of the business side of freelancing. Nice articles! Looking forward for some more!
Be glad you are other posters to this article on Incorporating are not working in California. Here, in California just to form a simple LLC or Partnership will cost a sweet $800.00 annually.
Don’t forget, you might have an annual business tax as well. Here in CT registered as an LLC, there is an annual $250 business entity tax.
~ Jenn
A thing to note about the US state of Maryland. You have to pay property taxes on any LLC or corporation, annually on your business assets. It is a $300.00 a year filing fee then you get a bill on claimed assets in the fall. I still think it’s worth it. There are things that pop up and this is one of those SURPRISE moments in being a small or sole business owner that make for never a dull moment.
I also advise http://www.nolo.com for a legal reference. I incorporated as an S corp and I am pretty happy with it. Corporations are pretty difficult to manage, but if you’re OCD like me, you can do it yourself. It just takes time but it’s well worth the experience. I incorporated with Incorporate.com which is in partnership with Nolo. It worked just great! When I received my incorporation package, I got four heavy books from Nolo editions, very usefull.
It cost me $900 to Incorporate. S-corps are subject to a $800 dollar annual fee by the state of California… BUT I get myself a reasonable salary for the work that I perform and everything else is passed through to me as profit on which I do not pay FICA (that cuts my taxes by 15% basically, on my profit)…
It’s just a matter of knowing what kind of money you’ll make and what business legal structure is the most interesting for you.
I went Ltd 18 months ago, got offices, an accountant and my first employee. Going Ltd It certainly helps you focus on your work as a business rather than owning a job.
For me in the UK, it was considerable beneficial tax-wise, and making the jump up to getting a good accountant. They are worth the extra.
thank god I live in mexico muahaha :p
America offers a great tax system for business owners. In Belgium (Europe) we are required to pay 652,31 EUR every 3 months. At the current dollar rate that means we have to pay $3405 annually. Quite expensive if you ask me.
@Andrew, I’m based in Maryland as well: they do enjoy making us jump through a couple more hoops, don’t they?
Thanks to everyone for chiming in about state specifics! I’m always leery about getting too far into details for states where I haven’t actually worked and might get things wrong.
I just started freelancing recently doing websites. I am near completion of my first freelance web site build and wondering what I need to do after the job is completed.
If I start doing more work I may consider incorporating.
Where can I find out what I need to do about taxes on the payment? I live in the U.S., in the state of Michigan.
Thanks, Great Article!
I could be wrong, but I think another benefit to incorporating yourself is that doing so will protect you from bankruptcy should something go wrong. Your business will take a hit, but if you get sued and end up having to pay out significant money, it wipes out your business account, not your personal checking and savings.
This probably varies from state to state though…
@Designgal34
That’s true for general incorporation. However, it can be done as a sole proprietorship as well. It’s more of a liability thing that people look into. It doesn’t necessarily vary from State to State, but more from Business Structure to Business Structure. For example, general partnerships is a business structure in which the partners’ funds could be taken from personal should bankruptcy or legal fees be needed. The liability for that is there. I believe S-Corporation and C-Corporation offer the same as LLC for liability being with the company and not individuals. As always, there’s ways around it. Check with your local attorneys for more information.
As for different State costs, I just finished creating my LLC in Hawaii. We pay a one-time $50 fee for incorporating, plus $20 for registering for State Tax License. Annual registration fee of $25. If you so chose, a Trade Name will cost you $25 as well.
Also, a reason for incorporating aside from tax purposes, is for future growth. Should you chose to later employ personnel, it makes maintaining the company name easier than re-branding yourself as a company. If you do choose to stay solo, I would recommend at the very least getting a Doing Business As (DBA) or Trade Name.
Well done Thursday, great article indeed.
- John
This is most interesting as I am setting up an S Corp this week. The thing that is stopping me is I was going to set the corporation up in Delaware (or Nevada) because of taxes. Someone and I will not mention said to be careful when setting a corporation up out-of-state as it will be hard to expedite financial matters. Could someone that has some experience with this please shed some light please with a comment.
I live in Texas and incorporated as an S Corp for $300. I put myself on a “reasonable” salary (W2) and save a lot of money on taxes. See Emmi’s comment above about FICA. Fortunately in Texas there are no corporate or franchise taxes for businesses making less than $300k a year. I am quite happy with the setup.