Should freelancers form an LLC or S corp?By Jillian Anthony August 9th, 2023
When you have multiple clients and 1099s, tax season can be a flurry of confusion, and Google can take you down a bewildering rabbit hole of contradictory advice. Taxes are complicated, and there’s no one-size-fits-all solution. But if you’re a freelancer debating whether to form an LLC vs S corp, here’s a practical guide on why one of these options may be the best choice for you—or why not.
I’ve been a full-time freelance writer and editor for about three years, and I formed Jillian Anthony LLC in Texas in April 2022. I did this based on information shared by experienced freelancers I follow online (and some scary legal battles I’d seen other writers go through). If you don’t form an LLC, you are personally vulnerable to legal challenges that may come your way based on the work you do. And in our increasingly litigious society, that’s a risk I’m not willing to take.
In February 2023, I began a six-month coaching program called “Wealth Expansion for Entrepreneurs” with financial educator Stella Gold, founder of My Gold Standard. Gold helped me level up my business, including opening a business credit card (Chase Business Ink) and checking account (Novo), but one of the first things they pushed me to get done was to form an S corp, which is an elective business and tax structure. (You can form an LLC and elect to be taxed as an S corp or form a C corp and opt for S corp taxation.) I worked with my accountant (who does all sorts of tasks for me that I don’t know how to do and never want to learn) to open the S corp and file my 2022 taxes through it. In the end, even though I made more money in 2022 than the previous year, I paid less in taxes. Texas has no income tax, which also helps.
To help me sort through the benefits and drawbacks of forming an LLC vs S corp for freelancers, I talked with Russell Garofalo, founder of Brass Taxes, which provides tax help for freelancers and artists. Garofalo started the company after he became a freelancer and realized that his taxes became more complicated, and few resources helped to explain those “gray areas” of business expenses and tax choices.
“It doesn’t need to be as bad as it is,” Garofalo says. “I genuinely feel like taxes shouldn’t suck so much.”
What is an LLC?
LLC stands for limited liability company, a legal business structure. It’s important to note that an LLC is not a tax designation, which means it will not change your taxes if you file as a sole proprietorship, which is the default filing method as an LLC.
How much does an LLC cost? Costs vary depending on the state you live in. To form an LLC, it can cost $50-$300 or more in some places, and annual costs can veer from nothing to about $300. It can also cost more if you have business partners.
Who can benefit most from an LLC? Any full-time freelancer who works alone and wants the legal protection and professional gravitas an LLC offers and who may experience large income fluctuations from year to year.
Some benefits when you form an LLC
Personal legal protection. An LLC is its own legal entity, which means you, as the business owner, are not personally responsible for the company’s debts and liabilities. For example, if someone sues you for libel for an article you wrote, they are suing the company, not the person, and your personal bank account and possessions are not at risk. And if your LLC needs to file for bankruptcy, the company would file, not you. “You should still have liability insurance,” Garofalo says.
Working as an LLC adds legitimacy to your work and could gain you better clients and higher rates. “It could potentially help people feel more comfortable paying you higher amounts,” Garofalo says. So, if you’re asking for $1/word for an assignment, someone may be more willing to pay Superstar Writers LLC that amount than plain old Jillian Anthony.
Limited legal restrictions and paperwork. Setting up an LLC is relatively easy and affordable, and there’s no upkeep other than paying an annual fee to keep it active and compliant. You (and your partners, if you have any) get to choose leadership and distribution of profits.
Taxation flexibility. As an LLC, you choose your business and taxation structure. You can apply to become an S corp or C corp or open an inexpensive DBA (Doing Business As) if there’s a different name you’d like to work under for some of your work (such as naming your dog walking business Ruff Stuff Inc.).
“A DBA is cheaper than setting up an LLC, and you can still be Superstar Writers and have a bank account and an EIN under that name,” Garofalo says.
Exclusive use of your business’s name. Once you register your business as an LLC, no one else in your state can use it.
The possible downside of an LLC
Recurring annual costs. Annual costs generally cap out at around $300. However, those costs are business expenses that can be written off.
What is an S corp?
An S corp stands for S corporation, a legal business structure common among small businesses (100 or fewer shareholders). Under an S corp, taxable income, credits, deductions, and losses pass directly to shareholders. To form an S corp, you must first form an LLC or a C corp, then elect to be taxed as an S corp.
Who can benefit most from an S corp? Freelancers who are making a steady, higher-than-average profit year over year. Figuring out what that means for you and whether or not an S corp is worth it can depend on several factors, which we’ll go into more below.
“[The internet] can make it seem like, ‘Hey, this is what rich people do, you should do it too,'” Garofalo says. “But there’s a lot of vagary in there. It depends on what the alternatives are, how much you’re making, and what your profit is. Is that just this year, or is that every year?”
How much does an S corp cost? Formation costs vary depending on the state, from $100 to $800. Plus, annual registration fees can cost between $20 to $800.
The top benefit when you form an S corp
The possibility of lower taxes. S corps are known as pass-through entities because they do not pay a corporate tax but instead pay their shareholders, who are responsible for taxes due.
“You’re an employee, and you’re a stockholder,” Garofalo says. “It’s messed up, but stockholders who are getting money out of a company they own pay lower taxes than employees do. Employees must pay taxes to cover Social Security and Medicare [plus income tax], but stockholders only have to pay income tax. So effectively, for the money you take out as a stockholder, you’re saving about 15% compared to if you took all that money as an employee.”
Fifteen percent can translate into significantly less money owed in taxes for a solo freelancer, keeping more money in your pocket.
The possible downsides of an S corp
High annual fees and complicated tax paperwork. As an S corp, your annual fees can jump up to $600 (like mine did) or more, and you’ll almost certainly want to pay a tax professional to handle your quarterly payroll and tax filings, which are required by law.
“Cost also depends on where you live,” Garofalo says. “New York City has taxes that make it less attractive to be an S corp. It can still make sense, but the profit needs to be a little higher.”
You have to pay yourself (and possibly others) in specific ways. “If you have your own S corp, you get paid as an employee, and you also get paid as a stockholder,” Garofalo says. “To pay yourself as an employee, you need to run payroll and deal with paycheck withholding, sending in the money to the federal government and the state government on behalf of your employee, who’s yourself.”
Payroll can be complicated, and using a payroll company to handle it can cost $50 or more per month, which adds up at the end of the year and eats into whatever you may save in taxes. An S corp also means you’re “creating and maintaining a whole separate set of finances,” Garofalo says. That means you must have a separate bank account, credit card, etc., to maintain any business you do as an S corp—and to pay yourself.
You must also decide on a “fair and reasonable salary.” Payments through an S corp to a corporate officer (that’s you) must be treated as reasonable compensation for services rendered. But there’s no official calculation for a percentage or dollar amount that meets that threshold. So you have to decide how to pay yourself so you’re getting the tax benefits an S corp can provide as well as satisfying the IRS.
This is where a tax advisor can come in handy, but remember that you’re ultimately responsible for the validity of your tax return, not your accountant.
The aggravation factor. Even if an S corp can save you a few thousand dollars, it may also cost you extra money and time.
“Everybody wants to save $2,000,” Garofalo says, “but if you actually make them go through the 40 hours of learning how to use and manage an S corp, it becomes much less appealing.”
Which business structure is right for you?
The right business structure for you depends on many factors, including your expected profit, the stability of your business, your legal and financial liabilities, how much time and money you’re willing to commit to administrative tasks, and much more. While an LLC offers you personal legal protection and credibility to your business, an S corp can potentially provide significant tax savings. It may be best to consult a tax or finance professional before making any big decisions about your business. Whatever you decide, don’t hesitate to make the choice that empowers you to reach your business goals and keep growing as a freelancer.
*Please note that this article is not business or legal tax advice but is solely for educational purposes.Image by johnstocker; photograph photo credit: Roungroat