Freelancers are often only focused on delivering great services and may easily neglect the administrative part of their business. However, freelancing isn’t just about freedom and independent work. It also has to do with managing many aspects of your entrepreneurial life. Organizing your business properly is just as important as ensuring high-quality work.
Apart from a sole proprietorship, freelancers can choose between two other business structures: LLC and corporation. To help you decide on the right model, we’ve come up with a corporation vs LLC comparison that will reveal which is better for one’s circumstances.
Corporation and LLC: a Brief Overview
The corporation comes with a well-established structure, easy share transferability, and perpetual life. All of these features matter if you’re looking to attract outside investors.
The owners of a corporation are its shareholders and the number of shares owned determines the ownership percentage. For instance, if a corporation has 2,000 outstanding shares and you own 1000 of them, you’re a 50% owner of the corporation.
Short for limited liability company, this structure is like a simplified version of the corporation. It’s more flexible in terms of taxation and management and has fewer record-keeping requirements.
If you start one, you’re entitled to liability protection from the debts that your LLC incurs. Owners can use their personal assets to make legal claims against the company. LLCs are quite common as the structure offers a similar liability shield as a corporation and is easier to set up.
S Corporation vs. LLC? How Are They Different
The S corp isn’t a business structure but rather a tax category. These corporations aren’t subject to corporate income tax so the profits are passed through to the owners, who would file personal income tax returns on those profits.
To be classified as an S corp., a company can’t have more than 100 shareholders. S corporations shareholders can’t be non-resident aliens, partnerships, or other corporations. What is more, these businesses can only have one class of shares to avoid being be taxed as a C corporation.
In terms of taxation, the main difference between LLC and S corp business structures is that S corp owners can be employees of the company. On the other hand, owners of LLCs are self-employed. As a result, LLC owners have to pay payroll (Social Security, Medicare) and income taxes on their share of the business’s profit.
Conversely, owners of S corps are supposed to pay themselves reasonable salaries for their work. With most payroll services, payroll taxes will be withheld and they’ll pay income tax on their salary later.
What Is Better, LLC or S Corp?
We’ll now take a closer look at the pros and cons of the LLC and the S corps and tell you which works better for freelancers.
There are many benefits of having an LLC:
Protection of Your Personal Assets
We’ve already mentioned the greatest benefit that the LLC brings to the table, which is limited personal liability. The importance of this detail can’t be overlooked.
For instance, if you start work without a formal business structure, the government will put you in the same bracket as your business. You’ll be responsible for paying business taxes on your personal tax returns. While this is a quick way to set your business in motion, it’s a rather precarious approach.
The reason for that is that you risk losing your personal assets if you get into legal trouble. The courts may take away your personal investment portfolio, cars, and even your home to meet liabilities incurred by your business activity.
But if you establish an LLC, you’ll have protection for your assets from most non-fraudulent liabilities that your business racks up.
Low Maintenance and Easy Setup
More often than not, freelancers are discouraged from setting up their business due to operational burdens and astronomical costs associated with corporations. In particular, an S corp requires quarterly government filings besides the initial. Other demands include shareholder and board meetings, payout level and corporate taxes, company minutes, record-keeping, and bylaws. That’s why freelancers are usually better off with an LLC.
Once you’ve formed your LLC, the only real requirement is to file the Articles of Organization. Even though the fee for submitting these differs, the amount is nearly negligible.
Other than that, you’ll probably need to come up with your Operating Agreement that will lay out the rules for governing your freelancing business. The rules normally include distribution details, new owners, and voting rights.
We’ll go through LLC tax treatment to demonstrate just how flexible it is. After setting up an LLC, people choose one of two forms of taxation:
· Corporate taxation – Sometimes called ‘double taxation.’ under this system freelancers pay a corporate tax rate and also personal taxes on the distribution on wages as employees or owners of the company.
· Pass-through taxation – Here, your earnings are taxed like partnerships. The business doesn’t incur any taxes – they are passed through to the owner.
The LLC combines partnership and corporate tax structures and takes full advantage of the benefits of both types. For example, single-member freelance businesses that meet S corp requirements can work under corporate taxation first and S corp taxation afterward.
Accordingly, you’ll avoid the initial tax and only pay your capital gain rates. This gives you an ideal combination of tax benefits.
That said, LLC isn’t a perfect business structure. This is what you need to consider before starting one:
Attracting Outside Investors Is Challenging
One of the main disadvantages of the LLC comes to the forefront when you need a quick injection of money. If you’re not eligible for bank loans, you’ll likely have a hard time attracting investors. Conversely, if you own a corporation, you may issue more shares in return for investor cash.
Costlier Than Partnerships and Sole Proprietorships
LLCs can be more expensive to start and operate than a partnership or sole proprietorship. You may be responsible for filing fees associated with your EIN and annual report fees.
S Corp Pros
The S corporation also brings a lot to the table:
No Federal Taxes
S corporations aren’t usually subject to federal taxes. For this reason, the structure can help owners save a lot of money on corporate taxes and the aforementioned double taxation. Similar to the sole proprietorship or LLC, this structure allows owners to report profits on personal tax returns.
Considering that established S corporations are committed to the shareholders, their credibility with customers, investors, and suppliers is higher. Owners also enjoy protection from personal liability, denying creditors access to non-company assets.
Dividends in an S corporation can serve as powerful incentives for employees to work and help the owner recruit talented workers.
S Corp Cons
The main drawbacks of using the S corp as a freelancer include:
This business structure isn’t as easy to manage as an LLCs when it comes to the establishment and operations. Namely, it requires the nomination of corporate officers and a board of directors, which are not present in an LLC. Furthermore, regulations and filing guidelines are more stringent for an S corp. You have to manage several challenging aspects, such as meeting minutes, stock shares issuance, and shareholder meetings.
A Host of Fees
An S corp can be subject to many fees, such as hiring registered agents, filing annual reports, and more.
Should I Start an S Corp or an LLC?
While the S corp has its benefits, the LLC is generally more favorable to freelancers. This is mainly because it’s easier to set up and comes with fewer establishment expenses. In addition, the taxation options are flexible, there are fewer fees, and the similar liability protection keeps your assets safe.
To sum up, freelancers have to consider many aspects when selecting their preferred business structure. You need to figure out if the tax requirements work for you and how much time you want to spend on administration.
In general, the LLC is a better option for freelancing work. It provides a simple and flexible form of organization that doesn’t prevent you from focusing on delivering high-quality products or services. In any event, the key is to organize your operations under a clear structure so you won’t face the risks associated with working as a freelancer.