Going into business invariably entails lots of decision-making, one of which will be to choose the legal structure of the business entity. As you know there are three choices: Sole Proprietorship, Limited Liability Company and Corporation, typically S Corporation for Freelance consultants and small business owners. Most Freelancers begin as Sole Proprietors and many remain there. If business-related liability is not an issue, then that is a perfectly acceptable choice. About 70% of US businesses are Sole Proprietorships. However at some point in the life of your business, perhaps as revenue and reputation grow, it may be preferable to move beyond Sole Proprietor status.
At any time, you may decide to operate your Freelance consultancy through an entity that limits your personal liability as the owner (alone or in partnership), decide that it’s worth the $500.00 or so filing fee (payable each year on renewal), plus maybe three hours of attorney or accountant fees to make sure everything is done the right way. Or maybe it’s not liability you’re worried about. Maybe you feel that you’ll appear to clients and prospects more “real” and the legal structure is more marketing tool than liability protection. Whatever your motive, the matter of selecting your consultancy’s legal entity will present itself. Should you structure your business as a corporation, or as an LLC? The answer to the question is— it depends.
Most Freelancers and small business owners are directed by their accountants and attorneys to the LLC. It’s flexible and easy to set up and file. Your state’s Secretary of State’s office will have a form online for you to inspect. There may be one or several owners of the LLC, but there must be a registered agent (to receive mailings associated with the LLC entity) who resides within the state.
A big advantage of organizing your business as an LLC is that you will receive protection from creditors of the business. If the business owes money, those to whom it owes money will not be able to come after personal property and other assets. Moreover, limited liability means that business owner(s) may not be held liable for debts that exceed their investment in the business. For example, if your investment in your Freelance operation is $5000.00 and you manage to incur business debts of $8000.00, you are potentially liable for only the $5000.00.
Furthermore, there is no separate business tax on the LLC. All business income and expenses “pass through” to the owner(s) of the business, who pay personal taxes only on the net profit, based on the share of business ownership. The owner of a single-entity LLC does not have to file a separate tax return for the business—all financial information is reported on form 1040. Schedule C Profit and Loss for a Business must also be filed ( you file schedule C also as a Sole Proprietor), where one may deduct all of the allowable pre-tax business expenses, i.e. advertising expenses, travel and entertainment, office supplies, etc. You must also pay self-employment tax, as do Sole Proprietors.
I was surprised to learn that an LLC can own property. In fact, if the property owned increases in value (and it probably will), your LLC will avoid the capital gains double taxation that regular corporations (C Corporations) would incur should the property be sold or the business entity liquidated. Like business expenses and profit, the capital gains would “pass through” to the owner(s).
One must be careful when doing business as a separate legal entity, though. Your LLC cannot become entwined with personal finances. Keep your grocery store charges, shopping sprees and personal vacations out of your business affairs. Failing to do so will cause LLC status to be forfeited. Moreover, an LLC terminates if one of the owners retires, resigns, dies or goes bankrupt (remaining owners can form a new LLC).
The LLC works best in relatively straightforward businesses, single- or multi-owner. If your goal is to raise money to vastly expand your business, then the business is advised to incorporate, so that investors will have the security of holding stock certificates as proof of ownership stake in the business. Ditto if you plan to take your company public. I’ll be back next week with a look at incorporating your Freelance consultancy.
Thanks for reading,