Should you incorporate your freelance business?

Should you incorporate your freelance business? The information in this post is based on my knowledge of the US market, so these tips may or may not apply to other countries. Additionally, I am not an accountant or an attorney, and you should speak with an accountant or attorney for specific advice.

When freelancers think about incorporating, it’s generally because of two reasons: taxes, and/or liability. Let’s take a look at both.

Incorporating for tax purposes makes a lot of sense for many freelancers. In the US, self-employment income is subject to an additional 15.3% in taxes, on top of what you would pay if you worked for an employer, because you pay both the employer and the employee portions of the Social Security and Medicare taxes. That’s a big hit. Certain corporate structures allow you to legally avoid paying self-employment tax on some of what you earn, by classifying some of your income as “wages” (subject to self-employment tax), and some of your income as “corporate profit” (not subject to self-employment tax), even though all of the money ultimately goes to you.

However, this comes with a tradeoff, namely that your corporation may be required to file payroll taxes four times a year, and a separate end-of-year tax return. In my case, I have an S-Corp, which is subject to those additional filing requirements. This costs me about $1,000 a year in accounting fees (because I despise accounting and outsource all of it to my accountant), but–because I take about half of my income as wages and the other half as corporate profit–it saves me about $6,000 a year in taxes, so it’s clearly a win. If your freelance income is relatively low, the tax advantage could be small or nonexistent. An additional consideration: this method–because it involves a deliberate decrease in the salary you pay yourself–could affect things like your future Social Security benefits, which are based on your average earnings over a certain period of years. It could also affect your ability to apply for a mortgage or other type of loan, because your W-2 income is a lot less than your gross income.

Incorporating for liability purposes is–in my opinion–a concept that many freelancers overvalue. Instead, I think that most people who are worried about liability should simply purchase professional liability insurance.

I’ve heard lots of freelancers say, “I don’t have to worry about having my house or savings taken away if a client sues me, because I’m incorporated.” Mmmmmmaybe. The liability protections you get from a corporate structure such as an LLC or an S-Corp don’t protect against liability due to your personal actions–such as translation mistakes. If you form an LLC, rent an office, and then can’t pay the rent, the LLC structure may prevent the landlord from coming after your personal assets. If you want to take out a business loan, a corporation is a good way to do that, because it may shield your personal assets. But if you’re worried about the indemnification clause in a translation contract, professional liability insurance is a much better option.

Before you incorporate, think about whether you’re a good candidate for that option. Filing as a sole proprietor (meaning a freelance business that is not incorporated) is very simple. Take how much you made, subtract your business expenses, and pay self-employment tax on the rest. You’re taking a tax hit, but you don’t have a lot of extraneous administrative overhead to keep up with. Forming a corporation can be financially advantageous, but may require you to file up to an additional five tax forms per year (four quarterly returns and a year-end return), plus you have to remember to renew the corporation’s status (normally through your State’s Secretary of State) every year.

One parting tip: If you use an accountant to prepare your taxes, use someone who is an IRS Enrolled Agent (EA). This designation means that the EA can represent you before the IRS, specifically in the event that you are audited or receive some sort of collection demand from the IRS. This happened to me: due to a mixup between my personal social security number and my business’ EIN, I received a demand letter from the IRS, stating that I owed $16,000 in taxes on undeclared income in my PayPal account. I knew that this wasn’t true, because I’m obsessive about declaring every cent I earn. Even if an official document translation client pays me in cash–which occasionally happens–I still declare it. However, dealing with this mixup could have taken hours of my time and still resulted in a penalty. Because my accountant is an EA, I simply scanned the letter, sent it to her, and she e-mailed me two days later, saying, “All set. We took care of it and it’s closed. You owe nothing.” This was worth every cent I’ve ever paid her, and I highly recommend using an EA if you don’t do your own taxes.

7 Responses to “Should you incorporate your freelance business?”
  1. Leticia Molinero January 24, 2019
    • Corinne McKay January 24, 2019
  2. Leticia Molinero January 24, 2019
  3. Marco Díaz February 7, 2019
    • Corinne McKay February 7, 2019
  4. Claudia Marchena February 13, 2019
    • Corinne McKay February 13, 2019

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