Examples:

• • Freelance writer Jill formed an LLC to separate her personal finances and shield herself if a client ever sued over her work.
  • Mike’s one-person software development shop is an S Corp, a separate entity where he’s the sole shareholder and employee.
  • Vanessa pays personal taxes on her share of net income from her graphic design LLC; profits aren’t taxed at the corporate level.
  • As an S Corp owner, Anita must follow certain formalities like adopting bylaws and holding annual meetings, even as a solo freelancer.
  • Liam’s marketing consultancy is an LLC because he wants the option to bring in other owners and investors down the line.

How to Proceed:

• • Weigh how important liability protection is based on your freelance field and client contracts – both S Corps and LLCs provide a shield.
  • Decide if you want your freelance biz to be a distinct legal entity or just an extension of you personally for simpler administration.
  • Consider if pass-through taxation works for you or if you’d prefer the S Corp option to be taxed as an employee and have the biz pay FICA taxes.
  • Evaluate your willingness to deal with more paperwork and ongoing formalities required with an S Corp structure.
  • Assess your future plans for expansion and bringing on partners/investors to see if S Corp ownership restrictions will be an issue.

FAQs:

• • Do I need to form an LLC or S Corp as a freelancer? While operating as a sole proprietor is an option, you’ll forgo the legal safeguards and potential tax benefits that come with forming an LLC or S Corporation for your freelance business.
  • Can I expect to owe less in taxes if I structure my freelance business as an S Corporation or a Limited Liability Company? It depends – S Corps can save on self-employment taxes, but LLCs may allow more write-offs. Talk to a CPA about your situation.
  • Can I form an S Corp with partners? Yes, but you’re limited to a max of 100 shareholders and they generally must be U.S. citizens/residents.
  • Do S Corps and LLCs protect me from all business liabilities? No, you’re still personally liable for anything you do wrong, like malpractice or breach of contract. Insurance can help mitigate those risks too.

Examples:

• • Ben’s LLC profits of $80K are taxed once on his 1040 at his personal rate; with an S Corp, he’d also have to file a separate biz return.
  • Carla pays 15.3% self-employment taxes on all her freelance design LLC profits, but she could save by taking some as an S Corp salary.
  • As an S Corp owner, Lee must pay herself a reasonable $60K salary before taking any distributions to avoid IRS scrutiny.
  • With both an S Corp or LLC, Ken can deduct his $500/month co-working space membership as a legitimate business expense.
  • Maria’s S Corp paid $2,250 in franchise tax on $150K net income, but her LLC fees would have been capped at $11,790 based on gross receipts.

How to Proceed:

• • Crunch the numbers on potential tax savings with self-employment tax and CA franchise tax based on your net income and gross receipts.
  • Determine a reasonable salary for your role based on market data and set up payroll if you go the S Corp route to pay it.
  • Keep detailed records of all business expenses that could qualify as tax deductions so you don’t leave money on the table.
  • Consider the added costs and complexities of filing both personal and corporate tax returns with an S Corp vs. one LLC return.
  • Maintain accurate books throughout the year to make tax time easier and compare how your liability changes with each structure.

FAQs:

• • As the owner of a Limited Liability Company, am I required to compensate myself in the form of a regular salary, or are there other options available? You can take owner’s draws, but you’ll pay self-employment taxes on your share of LLC profits.
  • Are there any legal constraints on how much or how little I can pay myself as an employee of my S Corporation, or is the salary amount entirely at my discretion?
    There’s no set rule, but it must be “reasonable compensation” based on your duties, industry standards, the company’s financial state.
  • If I fail to compensate myself with a reasonable wage as an S Corporation owner, what potential consequences could I face from the IRS? If you fail to pay yourself a reasonable salary and instead take excessive distributions, the IRS might recharacterize those payouts as compensation, subjecting you to additional taxes, fines, and interest charges retroactively.
  • Does California treat S Corps and LLCs differently for tax purposes? Yes, the franchise tax calculation and amount due varies greatly between the two structures.
  • Can I still use a standard 1040 form with an S Corp or LLC? Yes, but you’ll also need to attach Schedule C for sole props, Form 1120S for S Corps, or Form 1065 for partnerships.

Examples:

• • Tina filed Form LLC-1 and paid the $70 fee to officially form her consulting LLC with the state.
  • Marcus submitted his S Corp’s annual SI-550, confirming his business address, ownership, and service offerings hadn’t changed.
  • In his LLC operating agreement, Jason outlined how new members could be added and how the company would be dissolved if needed.
  • Come tax time, Patricia was glad she had kept her design S Corp’s funds in a separate bank account to easily track income and expenses.
  • Rick held an annual meeting for his one-person marketing S Corp and recorded key decisions to stay compliant with state law.

How to Proceed:

• • Decide on a name and file articles of organization (LLC) or incorporation (S Corp) with the CA Secretary of State, in person, by mail or online.
  • Mark your calendar to submit the initial and ongoing Statement of Information filings so you don’t fall out of good standing.
  • Draft a comprehensive operating agreement (LLC) or bylaws (S Corp) addressing key provisions like management structure, membership, dispute resolution, etc.
  • Open a dedicated business bank account and credit card to avoid commingling business and personal funds and piercing the corporate veil.
  • Set up a process to hold required S Corp meetings, notify shareholders, and record minutes to maintain this corporate formality even if you’re the only owner.

FAQs:

• • Can I form an S Corp without filing Articles of Incorporation? No, filing Articles of Incorporation with the state is required before electing S Corp tax treatment with the IRS.
  • What if I miss an SI-550 filing deadline? You may lose your good standing with a late fee of $250 and risk falling out of compliance with the state.
  • Should a lawyer draft the LLC operating agreement? It’s recommended to ensure it’s comprehensive and tailored to your needs, but some formation services also provide templates.
  • What if I use my personal bank account for my S Corp? You risk losing liability protection as courts may view the S Corp as a sham and hold you personally liable for business debts.

Examples:

• • Megan liked that her single-member LLC could be member-managed now but could switch to manager-managed if her business grew.
  • Robert served as the sole director and president of his S Corp, wearing both hats to oversee and manage his freelance business.
  • After a successful first year, Emily wanted to bring in her friend as a co-owner of her LLC, which was easier than adding a shareholder to an S Corp.
  • When Sam wanted to sell half of his software development S Corp, it was a straightforward process of selling 50% of his stock to the buyer.
  • Julia paid self-employment taxes on all her LLC profits, but she restructured as an S Corp to save by taking some as salary and some as distributions.

How to Proceed:

• • Evaluate if you want the simplicity of member-management or to delegate to a manager as your freelance business grows and changes.
  • Choose an entity type that aligns with your desired level of ownership control and oversight, either as an LLC member or S Corp director.
  • Assess your goals for bringing in partners, investors or selling the business down the line to determine if S Corp restrictions will be too limiting.
  • Consider if you want the ease of sale and transfer that comes with S Corp stock compared to LLC membership interests.
  • Weigh the potential tax advantages of being an S Corp owner-employee compared to an LLC member subject to self-employment taxes.

FAQs:

• • Can I be the only owner of an S Corp or LLC? Yes, single-member LLCs and S Corps with only one shareholder are permitted.
  • What happens if my S Corp exceeds 100 shareholders? It will automatically lose S Corp status and be taxed as a C Corporation.
  • Who can be an S Corp shareholder? S Corporation ownership is restricted to specific types of shareholders, namely individuals, particular trusts, and estates. Other business entities like corporations and partnerships cannot hold shares in an S Corp.
  • Can an LLC member just sell their interest to someone else? Per many states’ standard regulations, an LLC member is typically barred from unilaterally transferring their ownership stake to a third party without securing approval from the remaining members first.
  • Must I pay myself a salary if my freelance business is structured as an LLC, or are there alternative compensation options available to me as the owner? No, you can compensate yourself through draws/distributions and pay self-employment taxes on your profits.

Examples:

• • Alicia paid the $800 minimum franchise tax for her LLC, plus the $70 filing fee for her Articles of Organization.
  • Between tax filings, payroll costs and professional fees, Michael estimated he spent $2,500 on compliance for his S Corp last year.
  • When Tom’s S Corp was sued, the court upheld its liability protection since he had kept up with all corporate formalities.
  • Sara put aside 30% of her LLC profits each quarter to ensure she could cover her estimated self-employment and income taxes.
  • As Nick’s S Corp grew, he had to hire a CPA to handle his increasingly complex accounting, payroll and tax filing needs.

How to Proceed:

• • Research and budget for the formation and startup costs required for an LLC vs. S Corp, and be prepared to pay any associated fees.
  • Map out the ongoing compliance requirements and costs for each entity type to estimate the administrative burden.
  • Don’t overlook important formalities that seem like a hassle to preserve the vital liability protection benefit of the entity structure.
  • Work with an accountant to calculate your quarterly and annual tax payment and filing obligations for each option.
  • Assess your skills, bandwidth and budget for DIY business financial management vs. hiring professional help for your LLC or S Corp.

FAQs:

• • What are the typical formation costs for an LLC and S Corp in California? LLCs have $70-85 filing fees plus the $800 minimum franchise tax; S Corps have $100-250 filing fees.
  • Will I need an attorney or accountant for my LLC or S Corp? It’s advisable for S Corps given the complex requirements, and can be helpful for LLCs too – but not mandated.
  • What are the typical yearly expenses associated with maintaining an S Corporation’s tax obligations and administrative requirements, and how much should I budget for these costs as a freelancer? It varies widely but ballpark $2,000-$5,000 per year depending on your revenue, industry and complexity.
  • Are S Corporations or Limited Liability Companies at a higher risk of facing an IRS audit due to their distinct tax treatment and reporting requirements? S Corps may face more IRS scrutiny, particularly around reasonable compensation issues.
  • Do I really need to do all the S Corp formalities as a freelancer? The liability protection isn’t as strong if you don’t, so it’s best to keep up with requirements even if burdensome.

Questions:

• • 1. Which entity type offers stronger liability protection for freelancers?
    • A) LLC
    • B) S Corporation
    • C) Both offer similar protection
    • D) Neither protects your personal assets
  • 2. How are LLCs and S Corps taxed?
    • A) Both are separately taxable entities
    • B) Both have pass-through taxation
    • C) LLCs are pass-through, S Corps are separately taxed
    • D) S Corps are pass-through, LLCs are separately taxed
  • 3. Which requires more formalities and recordkeeping?
    • A) LLC
    • B) S Corporation
    • C) Both have similar requirements
    • D) Neither mandates any formalities
  • 4. Which entity type has ownership flexibility?
    • A) LLC – no restrictions on number or type of owners
    • B) S Corp – any number and type of shareholders
    • C) Both are flexible on ownership
    • D) Neither allows any ownership changes
  • 5. How can S Corp owners save on self-employment taxes?
    • A) By taking an owner’s draw instead of a salary
    • B) By taking distributions in addition to a reasonable salary
    • C) S Corp owners cannot obtain any self-employment tax savings
    • D) By paying themselves a low salary and high distributions

Answers:

• • 1. C) Both LLCs and S Corps provide similar limited liability protection for freelancers’ personal assets.
  • 2. B) Both Limited Liability Companies and S Corporations are pass-through entities for tax purposes, meaning the business itself doesn’t pay income tax. Instead, the company’s profits and losses are allocated to the owners and reported on their individual tax returns.
  • 3. B) S Corps face more extensive formalities, recordkeeping and reporting requirements compared to LLCs.
  • 4. A) Limited Liability Companies offer greater flexibility in ownership structure, with no restrictions on the number or types of members allowed. Conversely, S Corporations are subject to strict limitations, capping the number of shareholders and restricting ownership to specific categories.
  • 5. B) S Corporation owners can minimize their self-employment tax liability by paying themselves a fair market salary and taking any remaining profits as distributions. In contrast, LLC members must pay self-employment taxes on their entire share of the company’s earnings.

Disclaimer

Business entity selection is a complex decision that must account for each freelancer’s unique circumstances and goals. Laws and regulations impacting S Corps and LLCs may have changed since this article’s publication and can vary by industry, location and business specifics.

To determine the most suitable entity type for your freelance business, please consult an attorney, accountant and/or tax advisor licensed in your jurisdiction. They can provide personalized guidance based on a thorough review of your freelance operation and objectives.