One of the most important decisions that a freelance writer, or any small business person for that matter, will make is what form of business entity is right for them. There are a number of considerations. We will cover a few of the most common business entities for a small (often solo) entity like a freelance writing business. Note: We are not tax or legal consultants, and we encourage you to seek this type of advice before making this decision.
Common Business Entities for Small Businesses or Solo Entrepreneurs
The Small Business Administration defines a sole proprietorship as, “A sole proprietorship is the simplest and most common structure chosen to start a business. It is an unincorporated business owned and run by one individual with no distinction between the business and the owner. You are entitled to all profits and are responsible for all your business’s debts, losses and liabilities.”
This definition sums it up. You are the business. You benefit from all the income and are 100% on the hook for any liabilities. There is no corporate shield.
The advantage of being a sole proprietor is that it is simple and takes nothing to establish. There are several disadvantages:
- You will be subject to the self-employment tax. As an employee, the employer pays one-half of the FICA and Medicare taxes on your salary. As a sole proprietor, you pay all of this tax, though a portion is deductible.
- You have unlimited liability and can be sued directly, versus the veil of protection offered by a corporate entity.
A Sub-Chapter S Corporation is a special type of corporation available under the IRS rules. Like any corporation, an S-Corp must register as a corporation, obtain any needed business licenses, and file an annual report. None of this is terribly complicated, but you might want to enlist the aid of an attorney and perhaps a tax professional.
An S-Corp can result in tax savings for the freelance writer in terms of the self-employment tax. You will need to pay yourself a salary, but the self-employment tax will only impact the salary portion of your compensation. A portion of this tax impacts your personal return, the other half is paid by the business as part of the payroll taxes paid. Of note here, you must pay yourself a reasonable level of compensation, otherwise you risk scrutiny by the IRS.
Other income not paid to you as salary will be considered a distribution and is taxed at a lower rate and is not subject to the self-employment tax.
The S-Corp is a separate corporate entity with some liability protection. The corporate entity also has a life of its own and can live on even if you are no longer involved. This might not apply to most freelance writers, but if you do build a business with other shareholders this might come into play.
An S-Corp will require some additional administrative work and record keeping. This is not complex but does require a bit more work than simply being a sole proprietor.
An LLC or Limited Liability Company offers a number of advantages and disadvantages. It offers a level of legal protection for the owners from liabilities like a corporation, but the requirements are less structured than for a corporation.
Unlike with a corporation, there are no residency requirements. Owners are not required to be permanent U.S. residents or citizens.
With an LLC, the income is passed through to the owners and there are fewer start-up costs, as well as looser requirements for annual meetings, filings and administrative items in general.
On the negative side, an LLC might result in a higher tax bill for you.
LLC taxed as an S-Corp
Another option is to form an LLC and have the entity taxed as an S-Corp. This can provide several advantages for a freelance writer choosing this status.
The major advantage is that instead of being treated as a partner or member of the LLC for tax purposes and having all of your income pass through to your personal tax return, choosing to have the LLC taxed as an S-Corp allows you to be treated as an employee earning a salary.
Just as with an S-Corp, the ability to reduce self-employment tax is a key attraction of this entity form. The salary and distribution aspects are the same as with an S-Corp as described above.
When electing S-Corp status for your LLC you retain many of the looser administration and filing requirements of an LLC. To be clear, an LLC electing to file as an S-Corp is still an LLC.
A C Corporation is what one typically thinks of when dealing with a good-sized company all the way up to mega-corporations such as Fortune 500 firms. While this structure is an option for freelance writers, it is most likely overkill for most, if not all of you, reading this and we will not go into the details here.
New tax rules and pass-through entities
The new tax law passed at the end of 2017 includes new rules, including a tax break in some cases, for the taxation of pass-through entities such as sole proprietors, S-Corps, LLCs and some others. In some cases there will be a tax break.
This is a bit complicated and beyond the scope of this piece. We suggest that you consult your tax advisor to see how this might impact you and if you need to reconsider your business entity structure.
Many writers become freelancers out of a desire for independence, the variety of assignments they might capture and other reasons. Freelancers don’t always think of their work as a business, but in order to be successful financially, the entity form of your business is an important consideration.
The main issues to consider here are taxes, limiting your liability and ease of formation and maintenance. The S-Corp and the LLC are likely the next steps up from being a sole proprietor and both are not difficult to administer on an ongoing basis. It is a good idea to engage the services of an attorney or tax professional knowledgeable in these areas to help you in terms of deciding which entity form best meets your needs and in forming one the LLC or S-Corp if this is the route you choose.
Disclaimer: This article is meant as a guide for informational purposes only. It does not constitute a solicitation or provision of legal or financial advice, nor does it establish a client-attorney relationship. Please consult a professional in making any decisions for your business.