Do freelancers need an LLC? That’s a question many solo professionals ask as they start and grow their small businesses. While freelancers aren’t legally obligated to form a Limited Liability Company, doing so offers some advantages over operating as a Sole Proprietorship.
In this article, I’ll touch on the difference between running a freelance business as a Sole Proprietorship vs. an LLC. I’ll also summarize what’s involved in creating a Limited Liability Company and answer some frequently asked questions about operating as a freelance LLC.
Most freelancers choose to operate as either a Sole Proprietorship or a single-member LLC (an LLC with one owner). Both business structures offer administrative simplicity compared to operating as a corporation. So, what’s the difference?
A Sole Proprietorship is considered the same legal and tax-paying entity as its owner — there’s no separation; therefore, the owner’s personal assets are at risk if the business has financial or legal problems.
What about a sole proprietor’s tax responsibilities? The business gets taxed as a pass-through entity, with all profit and loss flowing through to the owner’s individual tax returns. In addition to paying income tax on profits, the sole proprietor must also pay self-employment taxes (Social Security and Medicare) on earnings. Self-employment taxes are akin to the FICA tax deducted from your paycheck when employed by someone else. Because sole proprietors do not receive a paycheck with income taxes and Social Security and Medicare tax withheld from their compensation, they must estimate their tax obligations quarterly and send estimated tax payments to the IRS and other tax authorities.
Forming a Sole Proprietorship requires no state registration paperwork. Basically, as soon as freelancers start doing business, they have established a Sole Proprietorship. However, they may have to file a DBA (Doing Business As) with the state or county if they want to market their business using a name that does not include their first and last name. For example, if Jenna Brown wishes to call her freelance writing business “Working Words” instead of something like “Jenna Brown Freelance Writing Services,” she would need to file a DBA to gain approval to use the fictitious name.
Depending on the state and local jurisdiction where a freelancer works, they may need to obtain certain business licenses or permits, too.
Sole proprietors pay themselves via owner’s draws (usually by writing themselves checks) from their business profits.
When a freelancer forms a single-member LLC, they create a separate legal entity for their business. So their personal assets gain some protection against the debts of the Limited Liability Company. In many circumstances, the freelancer’s home, retirement accounts, vehicle, etc., will not be up for grabs in lawsuits or to settle debts. However, an individual’s negligence or intentional malpractice can put their personal assets at risk.
A freelance LLC is considered the same entity as the business owner for tax purposes. Like in a Sole Proprietorship, LLC taxes are handled on a pass-through basis. All profit and loss flow through to the owner’s personal tax returns, and the freelancer is responsible for reporting and paying their taxes.
However, LLCs have tax flexibility that Sole Proprietorships do not. An LLC that meets the IRS’s qualification criteria can elect for S Corporation tax treatment. With the S Corporation election, the freelancer pays themselves as a company employee through payroll rather than owner’s draws. The freelancer can then take the remaining profit as distributions. Because wages and salaries are subject to Social Security and Medicare taxes, but profit distributions are not, this may help the freelancer minimize their overall tax liability.
To create an LLC, the freelancer must file formation documents (Articles of Organization, sometimes called Certificate of Organization) with their state. The LLC’s registered business name may be fictitious (no DBA filing necessary). Depending on where the LLC is formed and operates, it may need to obtain business licenses or permits and fulfill some ongoing compliance tasks (such as filing an annual report).
The requirements vary depending on the state. Generally, most freelancers must take the following steps to start an LLC:
Business licenses for freelance work vary according to where the individual lives and what they do. States, counties, and municipalities may have licensing and permit requirements applicable to all types of businesses, including freelancers. And sometimes, license and permit requirements are specific to certain industries and lines of work.
Examples of potential freelance business license requirements:
Freelancers who operate as a Sole Proprietorship and hire employees or form an LLC (even if they don’t have employees) will need to obtain an EIN. An EIN is a federal tax ID number issued by the IRS. Banks and other financial institutions typically want to know a freelancer’s EIN before opening any accounts in the business’s name.
Examples of common freelance tax responsibilities include income tax, Social Security and Medicare taxes, sales tax, and franchise tax.
Like other LLCs, a freelance LLC does not pay income taxes at the business level. By default, profit and loss flow through to the business owner’s personal tax returns, and income is taxed at the applicable individual tax rates. Note that some states do not levy a personal income tax.
In addition to federal, state, and local income tax (if applicable), freelancers pay self-employment taxes (Social Security and Medicare) on their business profits. Because no portion of the 12.4% Social Security and 2.9% Medicare tax burden is paid by an employer, the freelancer is responsible for the entire amount. Freelancers must estimate, report, and pay income and self-employment taxes quarterly.
If a freelancer elects to have their LLC taxed as an S Corporation, they might lower their self-employment tax burden. With S Corp status, the freelancer only pays Social Security and Medicare taxes on their wages and salaries from the business. The remaining profits taken as distributions are subject to income tax but not Social Security and Medicare taxes.
Other possible freelance taxes — such as sales tax or franchise tax — depend on the state and what types of services the freelancer provides.
Freelancers who choose the default LLC tax treatment pay themselves via owner’s draws from their business profits. Most business owners do this by writing a business check to themselves so they can transfer funds to their personal account.
If a freelancer elects for S Corporation status, they must put themselves on their business’s payroll and pay themselves a reasonable wage or salary via a paycheck or direct deposit. Any remaining business profits are passed through (and taxed as) distributions to the freelancer.
Whether you need an LLC as a freelancer depends on what you want for your business.
Consider the following questions when deciding on LLC formation:
These are helpful talking points for thinking through if an LLC is right for a freelance business. But every freelancer’s situation is unique in some way. I encourage solo business owners to discuss their circumstances with a knowledgeable lawyer and accounting professional. Research and the expertise of expert resources are the keys to making an informed decision that will start your freelance business on the right foot and keep it stepping in the right direction.
Forming an LLC is simple with CorpNet. We can take care of the paperwork for you, which lets you focus on building your business. And, our services are backed by a 100% satisfaction guarantee, so you know you’re in good hands.