If you’re a freelancer who is starting to make a substantial income, you should consider setting yourself up as a limited liability company. A CPA or a lawyer can help you form an LLC, or you can usually set it up through your state’s Department of State website. When you file an LLC, you separate yourself from your business, and your freelancing endeavor becomes an independent entity that employs you.
When your business becomes an independent entity, no one suing your business can touch your personal assets. They can only get at the assets of the business. If this seems like a good idea, then here’s a few things you should keep in mind.
You shouldn’t expect to save on your taxes when you become an LLC
Many freelancers considering turning their business into an LLC do so under the impression that it will help them save on their taxes. In general, however, becoming an LLC is not a tax-saving strategy. LLCs are taxed at the same rates as sole proprietors. There is an exception to the general rule, however. If your net income (the income that remains after you deduct your salary and your expenses from your revenue) is around $30,000, then, you save on taxes if you are an LLC and file as an S-corp. Until you get to such a level of revenue, becoming an LLC is mainly about protecting your assets in the event of a lawsuit.
Setting up an LLC isn’t very complicated because you will have help
If you aren’t familiar with the rules of setting up an LLC for the first time and dealing with questions to do with business finances, it can be intimidating. If you contact a bookkeeper or a CPA however, they are likely to make short work of it.
Many freelancers are uncomfortable with the idea of contacting a professional for their LLC needs because they don’t understand the law, finances or taxes, and fear looking incompetent. Sometimes, they worry about being told that their finances are a mess.
In reality, however, professional accountants do understand that regular people are unfamiliar with the rules, and can be very understanding.
Some freelancers stay away from setting up an LLC simply because they fear that doing so will likely attract an IRS audit. This is a misconception, however. Setting up an LLC does not make it more likely that you will be audited.
It’s important to look for a CPA who understands your business
You can’t expect to go to any CPA, and simply have them understand exactly what you need. Web design and development operates on a similar level to other “gig-economy” type jobs like wedding photographers, cake decorators, or kitchen and bath contractors, but each has it’s own inherent level of liability. You need to look for a CPA who is familiar with your specific industry. If a CPA misstates your industry or gets other details wrong, you should move on, and look for another one.
How much being an LLC costs you depends on where you live
On average, hiring a lawyer or a CPA to help you set up an LLC costs $500. Some states like California, however, apply an $800 franchise tax each year on LLCs. You owe this money even if you don’t make a profit. Before you set up an LLC, then, you need to perform a cost-benefit analysis.
On a side note: If you live in California, I would advocate that you move (if you are able) to a different state since California’s laws are the least business-friendly and you’ll end up paying WAY too much in taxes and fees (not to mention the cost of living and other expenses you have to live with that only apply to California). If you live in California, make sure to charge a fair rate for your work and factor all of these expenses in, because YOU will be the one to have to pay them.
If you set up an LLC, you need to act like one
To take advantage of the legal protections of being an LLC, you need to run your affairs as a proper LLC. You need to separate your personal finances from your business finances and prepare contracts each time you take on a project.
Many LLC owners make the mistake of skipping contracts and doing business informally or signing contracts in their own name, rather than in the name of their LLC. Unfortunately, when you make either one of these mistakes, you lose the protections that being an LLC brings.
Setting up an LLC lays the groundwork with which to establish healthy financial habits, and expand your business. It also offers protection to your assets. You do need to make sure that you go in with a qualified lawyer or CPA guiding you, however.
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