Freelancing is becoming very popular in today’s business world. In fact, a 2018 study found that more than 56 million people—about 34 percent of the national workforce—are freelancing in the U.S.
There are numerous benefits to freelancing, including a better work/life balance and greater flexibility compared to working for a traditional employer.
But are there risks involved in working as a freelancer? And does incorporating as a freelancer protect individuals against these risks?
When employees work for a traditional employer, the company protects against legal liabilities in the workplace. But freelancers are at risk when they are self-employed.
For example, negligence, defamation, confidentiality breaches, intellectual property infringement and data protection are the most common risks faced by freelancers.
As a freelancer, you’re responsible for self-employment taxes, to take care of Social Security and Medicare payroll taxes. You don’t have to worry about that as a full-time employee because employers split this expense with employees. But you will pay the total amount as a freelancer.
Understanding how to handle taxes a freelancer is notoriously ambiguous, but the easiest thing to remember is that you’ll not just owe taxes on April 15th…you’ll also have to send in estimated quarterly taxes to stay in the IRS’s good graces.
How much should you set aside for taxes? Roughtly 30% of your net income to cover your yearly tax obligations when you start freelancing. To save time, estimate how much you’ll owe at the end of the year at the beginning of the year.
After the first quarter of the calendar year (January, February, and March), calculate see how much you’ve already earned. Multiply that number by four, and you’ve got an estimate of how much you’ll earn this year. Let that number act as a guideline to help you figure out what you’ll owe each quarter and at the end of the year.
Failure to fully understand your tax obligations as a freelancer can be costly and land you in the hot seat with the IRS.
Both the legal risks and tax risks of freelancer are why some freelancers decide to protect themselves and their enterprise by forming a legitimate business.
What Are My Options?
Sole Proprietorship: One way to incorporate as a freelancer is a sole proprietorship, which is a one-person company. This means you are in the driver’s seat, controlling your salary and reporting all earnings and losses on your tax return.
It’s the quickest way to start a business and the easiest from a tax standpoint. As a sole proprietor, you don’t have to file a separate business tax return. Instead, you simply attach a Schedule C to your 1040 and file it with the IRS. Gains, losses, and other taxable items from your business are all combined.
But with simplicity comes risks. With no legal distinction between yourself and your business, business liabilities become personal liabilities. If sued, judgment can come against your personal assets meaning you risk losing everything for your business.
Limited Liability Company (LLC): After a sole proprietorship, an LLC is the next simplest structure to form. Creating an LLC means you are no longer considered the owner of your business, which means your personal assets are completely protected. When creating an LLC, be sure to separate all personal and business finances, and never combine them.
Setting up a separate bank account for your company makes it easier to for you do business manage a cash balance, deduct business expenses for taxes, conduct proper accounting, and execute employee payroll. It also provides better protection if legal action is taken against your company.
Additionally, business bank accounts create historical relevance through the relationship established with the bank, and can create unrestricted access to long-term funding options, business credit cards, and other financial solutions.
Some freelancers choose to incorporate in order to limit their personal liability. Others incorporate to gain the tax benefits that LLCs provide.
For example, in an LLC, you can choose to pay all of your taxes via your personal tax return or pay corporation taxes and use your personal tax return to claim the salary you receive from the LLC. This is quite beneficial for freelancers who want to keep their salary in a low tax bracket and pay a lower corporate tax.
In addition, some freelancers choose to form an LLC because they believe it makes them a more legitimate business. Unlike a sole proprietorship, and LLC is an official company with a formal business name and number. And this makes some freelancers feel more professional, credible and respected within the business world.
Incorporating as a freelancer not only puts a legal shield around you and your business, it makes filing taxes easier and can save you thousands of dollars annually.
If you are unsure about incorporating, consult a business start-up specialist at Inc Authority to determine what entity is best for you. Call us at 866-545-1867.