Being a freelancer is a great way to have career freedom, even though tax burdens can often bring unexpected challenges. Tax issues sometimes come up based on how your business is structured.
Do you consider your freelance business an LLC, or an S Corporation? The difference between the two is relatively wide, but you need to look at these options before becoming an official freelancer.
Let's look at the differences between them and what your best option is based on calculating taxes for your business.
Defining What an LLC is
When you structure your business as an LLC, you're bringing a lot more independence to what you do. You're potentially legally separating yourself from having any business partners.
In many ways, being an LLC is an easier way to manage your business because you don't have as many tax reporting requirements. You only have to file a personal return, hence why so many small businesses prefer to be LLCs.
Perhaps you're merely a one-person band while working as a freelancer. If so, structuring as an LLC is the most appropriate action to take. This isn't to say LLCs always have one person in charge. It all depends on how many employees and partners are involved in your business.
Keep in mind two subcategories of LLCs exist in terms of taxes. You're either a single-member LLC (meaning running your business on your own), or a multi-member LCC where business partnerships are involved.
Defining What an S-Corporation is
By contrast, an S-Corp isn't a typical business structure. You'd only declare this as a tax designation. An S-Corp is also still essentially an LLC, except you're declaring how you want to be taxed.
Filing as a C-Corp means your LLC would be taxed as a corporation, something leading to bigger taxes. Filing as an S-Corp allows you to save money on Social Security and Medicare as just two benefits.
Much of this has to do with how you pay taxes off the salary you make in your S-Corp. Just remember you can't file as an S-Corp if you're the only one running your small business.
What Kind of Taxes Will You Pay as an LLC?
The "LL" in an LLC stands for "limited liability", which tells you everything about how you pay taxes. Filing as an LLC gives you more freedom in how you want to be taxed.
If you're strictly designated as an LLC, you only have to report your income through a Schedule C as any solo freelancer would. While being an LLC does give you more freedom on how to report your earnings for taxes, it doesn't necessarily save you the most amount of money.
Sure, a corporation is always taxed higher. As an LLC, you're still going to have to pay taxes on Social Security and Medicare based on your profits. Should this be a problem for you financially over time, you might want to consider the idea of paying taxes as an S-Corp.
What Kind of Taxes Will You Pay as an S-Corp?
When you choose to designate as an S-Corp, you're taking all your profits, losses, and taxes and reporting them straight through you. You're filing a personal income tax return in this case, potentially saving you more money.
What this means for you is you're taxed strictly on profits from your company and don't have to pay self-employment tax. This alone likely would appeal to any freelancer who wants to avoid the high self-employment rate. Again, you still can't technically be an S-Corp if you're just one person providing services to your customers.
The other best aspect of being an S-Corp is you don't have to pay into Social Security or Medicare, saving you exponential money on your taxes. Not that taxes may not still be substantial if you make a big salary.
It's not always about being a solo freelancer. Your choice of whether to file as an S-Corp might have another reason behind it.
Are You Making a Profit?
You can still be an independent freelancer and not make a profit during a tax year. Your best method of determining whether to file as an S-Corp is whether you're making a real profit. If you are, filing this way is clearly the best option.
Challenges might still apply, including taking longer to fill out your tax return, not including tax withholding taking extra time. At least you do have some significant time to make your final decision on whether you choose to become an S-Corp. All freelancers have up to 75 days to make a final decision after going into business.
In this regard, you need to think about what kind of freelance business you really have. Don't put off making a decision because you're too busy with other business matters.
Now you'll want to know what kind of tax forms you file after officially incorporating as an S-Corp or LLC.
What Tax Forms Do You File as an LLC?
Once you've done a thorough analysis with a lawyer or accountant about whether you're an LLC, it's time to consider the tax forms you need to fill out. For an LLC, you only need to file a typical Schedule C with your 1040 tax return.
As the IRS points out, some businesses can't be LLC, like banks and insurance companies. In most states, you can still file as a single-member LLC.
What Tax Forms Do You File as an S-Corp?
After deciding you're an S-Corp, filing your taxes is going to become a little more complicated. First, you need to fill out Form 2553. This needs to be signed by all the shareholders in your business.
Other filing requirements are needed, like 1120S for reporting income taxes, plus 1120-W for estimated taxes. Also needed are employment tax forms 940, 941, or 943. A 943 is strictly for farming employment.
Excise taxes are also required, usually required if using gasoline, doing wagering, or for truck highway usage.
Don't forget to pay income taxes using the 1040 or 1040-SR forms.