"Corporations are like protean bacteria; you hit them with accountability and they mutate and change their names." — Doug Anderson
One of my biggest mistakes early in my freelancing career was cashing my clients' checks into my personal checking account. This is bad for a couple reasons:
- You're less likely to set aside money to pay your taxes each quarter.
- You're less likely to deduct the expenses for your business since they'll be mixed in with things like rent and groceries.
If you're like I was when I started freelancing, you're operating as a sole proprietor and are paying self-employment tax for the portion of your income that comes from your freelance gigs. When you get a check from your clients, it's made out to you—not a company name. And when you enter into contract with your clients, you enter into it under your own name, too.
All of this is perfectly legal, but there's a better way to structure your business to help insulate your business from your personal life.
Limit Your Liability
In the United States, most jurisdictions recognize limited liability companies to provide the owners of a company with legal protections.
For our purposes as freelance creative professionals, LLC's are a fantastic vehicle for running our businesses. They combine the pass-through taxation of a sole proprietorship with the limited liability of a corporation. This means that income generated through your LLC will "pass through" onto your personal income tax return, but you are not personally liable for damages related to your business. If someone sues your LLC, they can't touch your personal assets.
But Wait, There's More!
An LLC is a great vehicle for insulating your business from risk, but because the money that comes into an LLC is taxed directly as personal income, it doesn't do a very good job insulating our business from taxes.
For our purposes, we're actually going to use a hybrid of an LLC and an S corporation.
When you hear the word corporation, you probably think of offices and managers and overpaid CEO's and bureaucracy. But really, a corporation is just a group of people authorized to act as a single entity and recognized as such in law.
When you form a corporation, it's like you're giving birth to a new person! It has its own Social Security number called an Employer Identification Number (EIN). It can open bank accounts and take out loans. It's your new profit-seeking imaginary friend.
A corporation is owned and controlled by its members. Depending on the structure of the corporation, its members are either appointed as officers or are made members through the purchase of company stock. Officers and shareholders cast their influence into the operations of the corporation for the express function of producing profit.
What does this have to do with freelancing? I'm just one person, not a corporation! When you form a corporation as a freelancer, you'll be the sole member and the sole employee.
An S Corporation (S Corp) is a special type of corporation where the income and losses are divided among and passed through to its shareholders. It gets its name from its corresponding subchapter (Subchapter S) of Chapter 1 of the Internal Revenue Code. When you organize your business as an S Corporation, you're able to pay yourself a salary and take some income in the form of dividends from the company. Because of this, you'll only be liable for self employment tax on the portion of your income taken as a salary. This can reduce your overall tax burden substantially.
The IRS allows electing to have your LLC taxed as an S corporation. Your company will remain an LLC from a legal standpoint, but for tax purposes, you'll be an S corp.
Please talk to a tax professional in your area about the pros and cons of using an LLC S corp election in your state.
Forming Your LLC
Before you begin, make sure you've contacted a tax professional in your area to assist you in these steps, as there may be better options in your state.
Search your state's business registry to make sure your chosen business name is available. Visit your state's Secretary of State website and look for a link called "Business Directory" or "Corporation Search". Make sure the name you've chosen is available. Note: It's really easy to spend way more time picking a name than it's worth. Pick something unique, easy to spell, easy to remember, and move on. You can always use a dba ("doing business as") name in its place.
Download and fill out the LLC Certificate of Formation form for your state. This form will ask for your company name, place of business, and other details. For example, here is the Washington State LLC Certificate of Formation.
Apply for an Employer Identification Number (EIN) using IRS Form SS-4. Like a Social Security number, your EIN identifies your corporation with the IRS for tax purposes.
Elect to pay taxes from your LLC as an S corporation using IRS Form 2553.
Open a business bank account at your local credit union. Once the office of the Secretary of State sends you your finalized certificate of formation, go to a credit union to open a business account. They'll need your business's identification information in order to open an account. I recommend using a credit union over a bank because they typically have better customer service and fewer fees. Plus, it's great to keep money in your community!
Now that you've got your own company, let's get you paid.