Many freelancers derive substantial benefits from forming a single-member LLC. But there are pros and cons to consider in making this decision. This article explains a) what an LLC is and why you may want one for your freelance business, and b) what factors you should consider when deciding whether to set up an LLC.
Single Member LLCs – What are they and how they can help freelancers.
In the United States, if you independently (i.e., not as an employee or partner) start making money in some way, you’re generally considered to be a “sole proprietor.” We like to use the example of a lemonade stand: if you’ve ever spent a summer afternoon in your childhood selling lemonade on a street corner, you were operating as a sole proprietor in the eyes of the law. Being a sole proprietor is a default status, meaning you don’t have to do anything to become a sole proprietor. If you’re working for yourself and earning money, you’re automatically a sole proprietor.
But that doesn’t mean you have to be a sole proprietor. You can form what’s called a corporate entity. There are various forms of a corporate entity, but the go-to choice for the vast majority of freelancers is the Limited Liability Company (LLC).
For freelancers, the key benefits to forming an LLC are:
Pro #1 – Protect Your Personal Liability with the “Corporate Veil”
When you do business as a sole proprietor, there is no legal distinction between you and your business. If you borrow money for your business, you owe that money back regardless of what happens with the business. If you get sued for something that happens in relation to your business, you will be sued personally. In other words, as a sole proprietor, you are your business.
By creating an LLC, you create a separate “legal person” for your business. You control that ‘person,’ but it is separate from you. It creates a sort of firewall between your personal finances and what happens with your business. This means that if your LLC owes someone money, that doesn’t necessarily mean that you owe that person money. Lawyers call this barrier the “corporate veil”, and it is one of the key reasons why people set up corporate entities. Courts will only allow creditors or legal claimants to “pierce the corporate veil” in certain limited circumstances (e.g., if the individuals who own the business have committed a deliberate fraud). For centuries, policymakers have developed this system because it is believed to promote entrepreneurship and economic activity.
By forming an LLC for your freelance business, you can rest easy at night knowing that if your business ever gets blindsided by a lawsuit or becomes mired in business debt, you can simply walk away from it, rather than facing personal financial ruin.
Pro #2 – Look Professional
Forming an LLC can also provide a marketing benefit. The fact that you’ve taken the time to set up an entity for your business shows a certain level of commitment to potential clients or customers. It suggests to them that you probably didn’t start doing this yesterday, on a whim. It also shows a certain level of business savvy.
Pro #3 – Tax Benefits
In certain circumstances, forming an LLC for your freelance business may provide some tax benefits. Generally, a sole proprietor can take the same business-related tax deductions that an LLC can, so there are not many benefits there. But an LLC can apply for something called S-Corporation status with the IRS, which may reduce tax liability for certain high-earning freelancers. For more on this, read our article: “Are there tax benefits for freelancers who form an LLC?”
Pro #4 – Selling your LLC
If you think that you may want to sell your entire freelance business someday, having an LLC could provide some benefits. As a sole proprietor, you are your business, and you can’t sell yourself in a literal sense, so in order to sell your business, you would have to painstakingly define whatever it is you are selling. If your business is an LLC, however, it is usually more clear what belongs to you and what belongs to the business. That can make it easier to sell the entire business in one fell swoop.
But creating an LLC is not all upside. There are drawbacks to consider as well. Before you jump into setting up an LLC, consider the following ‘cons’:
Con #1 - Administrative Expenses and Time
Setting up a single-member LLC does cost money. You may need to pay an attorney or non-legal service to set it up (although Wingspan members get this for free ). In most states, you will also likely need to pay an annual or bi-annual fee to keep your LLC in existence. This fee can range from $50 to $800, depending on which state you run your LLC in. There are also additional services you may find yourself needing with your LLC, such as a registered agent service. For more on this, read our articles: “How much does it cost to set up and maintain an LLC?” and “What is a registered agent?”
Having an LLC can also complicate your taxes slightly. Your tax preparation service or accountant may have to do a bit more work than they would if you were operating as a sole proprietor.
Lastly, setting up an LLC does require a minor time commitment. In most states, you will have to file an annual report (usually, a simple form) and keep track of certain deadlines.
Con #2 - Distinct Legal Treatment
Another con to having an LLC for your freelance business can arise in a variety of legal contexts where your business might be treated differently because it is a “corporate entity” and not just you. Some state and federal laws protect workers--even freelance workers / independent contractors--more robustly than companies. For example, sole proprietors who have not been paid by for their work sometimes succeed with the argument that a court should treat them as an employee, and give them certain additional remedies that the law provides to employees who have not been paid by their employers, such as attorneys’ fees and double damages, or the right to compensation for travel or overtime.
Once you transform your business from an individual (a sole proprietor) to a company (a corporate entity), you may lose certain advantages that the law provides to individual workers.
How to decide whether or not your freelance business needs an LLC
If you’ve read the last section and you’re still feeling unsure about whether you should set up an LLC for your freelance business, we recommend you consider the following key factors, in order of importance.
#1 – How much money do you expect to make from your freelance business?
When considering whether an LLC is worth the effort/expense, it’s critical to weigh in how much money you are making from your freelance business. For example, if you live in North Carolina and have a freelancing is side-gig that only nets you about $5,000 per year, you may want to think twice about paying $200 per year to the state to cover fees/taxes required to keep the LLC active. That’s 4% of your income out the window! On the other hand, if you’re a full-time freelancer earning $200,000, then $200 per year might look like a smaller cost of doing business.
**#2 – What state do you want to set up your LLC in?
In the last factor, we used the example of North Carolina. But the cost of setting up and maintaining an LLC varies by state. In Minnesota, for example, there is no annual fee to keep your LLC in existence so long as you file your forms on time. By contrast, California is the most expensive state to have an LLC in; it requires payment of at least $800 per year! So a freelancer in California might be more hesitant to set up an LLC than a freelancer in Minnesota. For more on this, read our article “What state should I set up my LLC in?”
#3 – Is your freelance business more or less likely to get sued?
Because the main advantage of a single-member LLC is the “corporate veil”—the firewall between your business’s finances and your personal finances—you should definitely consider the likelihood that you will ever be sued. For example, if you’re a freelance ski instructor, you might lean towards going with an LLC because of the possibility that a litigious client might hurt themselves during a lesson and file a personal injury lawsuit against you. If, by contrast, you are merely a freelance researcher, it is harder to imagine how and why you would ever be sued for something you inadvertently do on the job, so you might opt to keep doing business as a sole proprietor.
Another aspect of your freelance business that could increase the risk of liability is whether you plan to have employees or subcontractors. These commercial relationships could lead to disputes if, for example, an employee or subcontractor thinks you’ve underpaid them. In that case, you might be glad you decided to set up an LLC.
#4 – Are you independently wealthy?
There is wisdom in the saying that ‘if you’ve got nothing, you’ve got nothing to lose.’ If you don’t own a home or any other major assets, you will be less attractive to plaintiff’s lawyers who may consider suing you for something you do as part of your freelance business. If, on the other hand, you are the heir to a massive fortune, you should seriously consider protecting your personal assets from any liability that could arise on the job.
#5 – Does your freelance business need to borrow a lot of money or enter into leases?
Many freelancers don’t require much capital to get their business going. They just open up shop and start working. But if you need to borrow money or enter into payment obligations (e.g., an office lease) to get started, you may want to try to avoid being personally liable for that debt. In that case, you may derive more value from setting up an LLC, and borrowing money in the name of that LLC, if possible.
#6 – Do you think you may want to sell or share your business in the future
As noted above, LLCs are generally considered to be easier to sell than a sole proprietorship, because the separation between you and your business is more defined. Similarly, with an LLC, you can also share ownership of the LLC with other people. If these are things you may want to do, that should tip the scales towards setting up an LLC.
We hope this article has given you a better sense of how you might benefit from setting up an LLC for your freelance business, and whether it’s worth the drawbacks. Please read the disclaimer below, however, and note that this is general information that might not address issues specific to your situation.
In particular, we strongly recommend that you seek more specific guidance if: (1) your LLC will own real estate or other major assets, (2) you are a professional (a doctor, lawyer, dentist or architect), (3) you have business partners or investors in your freelance business, (4) you live outside the U.S., or (4) you are working in the U.S. through a visa or immigration-related work authorization.
Relatedly, you may also want to take a look at these articles when making your decision: “Do I need an LLC to open a business banking account?”; “What’s an EIN and do freelancers need it?; “Do I need an EIN to open a business banking account?” and “50 State Overview to Forming an LLC”
Are there tax benefits for freelancers who form an LLC?
For many freelancers, an LLC won't provide any tangible tax benefits. Most deductions that can be taken by a single-member LLC can also be taken by a sole proprietor (e.g. a freelancer without an LLC or any other corporate entity). So you shouldn't expect to see immediate tax savings from forming an LLC.
In a handful of states, LLCs are also subject to specific state taxes.
However, in certain cases, an LLC can confer benefits because it allows its owners to choose how the entity should be taxed. If you own a single-member LLC, you may elect to be taxed as a sole proprietor or C-Corporation. Some single-member LLCs may also be eligible to be taxed as an S-Corporation, which can confer tax saving opportunities to certain high-earners.
It gets a little complicated. The take-away here is that you know an LLC has options as it relates to taxation. Because every tax situation is unique, you should speak to your tax advisor before moving forward with a S-corporation tax election.
How much does it cost to set up and maintain an LLC?
The bottom-line startup cost of forming an LLC consists of state fees and service fees. They usually range from $50-400 depending on the State. Part of the cost of forming an LLC is ongoing fees. While there is less paperwork involved in maintaining an LLC, there are still yearly LLC filing fees by state. Some states do have an annual flat tax that applies to all LLCs. In California, the minimum tax is $800 per year. In other states, such as Delaware, it is lower, at $300 per year. In addition to your LLC filing fees, most states require annual fees, often called reporting fees, to maintain your LLC. This fee is in addition to any franchise tax.
What is a registered agent?
If you have an LLC, you need a registered agent. If you’re a small business owner who’s recently decided an LLC, or limited liability company, is the right business structure for your business, and you’ve started preparing your formation papers or Articles of Organization, you probably know by now that you’ll need a registered agent. An LLC registered agent is an individual or entity which has been designated by the LLC to receive service of process notices, government correspondence, and compliance-related documents on behalf of the LLC. Designating yourself or another member of your LLC as your registered agent is also an option.
What state should I set up my LLC in?
When you decide to start a limited liability company (LLC), you can choose to form your company in any state, regardless of where you are based. But in most circumstances, your home state is going to be your most effective option. If you were to form your business in another state, you will still likely meet the criteria for doing business in your home state. So, even if you were to form your business in Delaware, Nevada, or Wyoming, you would have to file paperwork in your home state, eliminating any tax or cost savings.
Do I need an LLC to open a business banking account?
You don't need to be an established LLC or corporation to open a business bank account. Sole proprietors may only need to provide a tax ID or Social Security number, while corporations may need to submit more extensive documentation
Do I need an EIN to open a business banking account?
Remember: Single-member LLCs do not need EIN numbers, unless you hire an employee.
So, if you have an EIN, give it to your Bank for account opening. If you don’t, it’s fine! You can use your social security number (SSN) or your Individual Taxpayer Identification Number (ITIN), especially if you’re a non-U.S. citizen.
John J. Thompson is a Manhattan-based business attorney who advises freelancers and businesses.
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