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Should You Incorporate Your Freelance or Consulting Business?

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Should You Incorporate Your Freelance or Consulting Business?

By Caron_Beesley, Contributor
Published: October 26, 2011 Updated: March 2, 2012

If you are a consultant or freelancer you’ll be familiar with this often asked, yet perplexing question: “Do I need to incorporate?”  

Legally, the answer is no. The truth is over 70 percent of U.S. businesses are owned by sole proprietors, and operate successfully without incorporating.

So, if you can legally operate and be successful without it, why would you want to incorporate your business? Here are some reasons why:

Liability

You may not think now that you need protection against liability but what if a client holds you in breach of contract? Can you afford to put your personal assets at risk to satisfy any claims against your business? As a sole proprietor there is no legal distinction between the owner and the business, this means that you are personally liable for all business losses and debts.

Business incorporation can limit your liability as a business owner, essentially putting your personal assets off limits if anyone brings a judgment against you.

Tax Savings

There are multiple types of corporations, many of which can offer tax benefits. S Corporations, for example, are a popular choice for small business owners and can reap payroll tax savings. How does this work?

Well, let’s compare a sole proprietorship and an S Corporation, both of which make $80,000 in sales a year. The sole proprietor might expect to pay $9,000 in federal income taxes as well as state taxes. However, the sole proprietor also will pay 15.3 percent in employment tax (for social security and Medicare) on the $80,000, equal to $12,240.

In the case of the S Corporation, assuming it is owned by a single shareholder, only earnings paid to the owner as a salary are subject to employment taxes. Any money left in the business for reinvestment or distributed to the shareholder as a dividend is not subject to self-employment tax. So, going back to our example, the S Corp owner might choose to take $35,000 in salary and take the remaining $45,000 as profit through a distribution. Because S Corporations only pay employment taxes on salaries, the owner is only liable for $5,355 in taxes – a lot less than the sole proprietor!

That being said, the tax savings of the S Corp come at a price. S Corps require scheduled director and shareholder meetings, minutes from those meetings, adoption and updates to by-laws, stock transfers, and records maintenance.

Another popular incorporation option is a Limited Liability Company (LLC). However, the IRS does differentiate LLCs from sole proprietorships. Instead LLC owners are taxed much like sole proprietors are on the entire net income of the LLC.

If you incorporate you can also expect your tax preparation costs to go up. If you’re a freelancer, a $1,000 tax preparation fee is a significant chunk of change that you need to be aware of.

So in summary, you can gain tax benefits through incorporation, and it is one of the biggest drivers for doing so. But it’s not the same for each type of incorporation, and a tax advisor would be your best bet for advice on this matter.

Raising Capital

If you are hoping to expand your consulting business, raising capital as a sole proprietor can be tricky.  You can get a loan but it would be considered a personal loan since sole proprietorship is not a separate business entity apart from you. Registering as an LLC, rather than a corporation, is a low-cost way to incorporate and separate your personal and business assets.

Increase Your Credibility

Whether you are looking to grow your business or hire employees, having “Inc” or “Corp” after your business name brings with it a lot more credibility than a sole proprietorship does.

How to Incorporate

If you have chosen to incorporate your company, you will need to pursue the process directly with your state. Read more about the steps involved in incorporating your consulting business in SBA’s Business Incorporation Guide. This informative blog also explains some of the pros and cons of the two more popular forms of business incorporation: Should My Company be an LLC, an S Corp, or Both?

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About the Author:

Caron Beesley

Contributor

Caron Beesley is a small business owner, a writer, and marketing communications consultant. Caron works with the SBA.gov team to promote essential government resources that help entrepreneurs and small business owners start-up, grow and succeed. Follow Caron on Twitter: @caronbeesley

Comments:

Incorporating have it's own benefit and drawbacks. Deciding whether to incorporate or not and if yes when to incorporate is a very crucial decision making process. Taking care of this thing will make your business and if not might brake your business as well. If you are a freelancer on a small level better keep yourself away from such steps.
Wow, I didn't know that you could save the 15.5% self employment tax if you were a corporation. I'll have to look into that, it could make a huge difference. Thanks for the info.
where can I get additional info regarding the tax saving for some types of corporations?
where can I get additional info regarding the tax saving for some types of corporations?
This discussion unexpectedly takes my attention to join inside. Well, after I read all of them, it gives me new idea for my site. Thanks for sharing and keep up the good work.
Can I just say what a relief to find someone who actually knows what theyre talking about on the internet. You definitely know how to bring an issue to light and make it important. More people need to read this and understand this side of the story. I cant believe youre not more popular because you definitely have the gift.
In my opinion, Incorporating isn't without its potential disadvantages. There are costs associated with setting up your corporation and the tax benefits don't apply to everyone.
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Hi, I enjoyed reading your articles. This is truly a great read for me. I have bookmarked it and I am looking forward to reading new articles. Please keep up the good articles!
where can I get additional info regarding the tax saving for some types of corporations?

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