Taxes for Freelancers: The Pros and Cons of Registering Your Freelance Income as an LLC or S-Corp

If you’ve been freelancing on the side of your full-time job over the past few years, you’re not alone.

In three short years, gig workers are expected to rake in over $450 billion.

And as companies reel with the economic impacts of the coronavirus pandemic, more and more people will join the gig economy to build additional streams of income or create a new career for themselves.

Why Should I File My Freelance Income Separate from Personal Income?

Picture this: You’re a graphic designer that works for an organization in Boston, and you make $45,000 per year plus benefits. You like the stability of a 9 to 5, but you’re also looking to be more creative in your spare time. It wouldn’t hurt to earn a few extra bucks moonlighting, right?

After a few days’ work of setting up an online portfolio and profiles on a few freelance sites, you start designing logos and brochures for a handful of clients that pay you through various channels: Fiverr, Upwork, PayPal, and more.

Girl with Money

That income is all deposited into your personal bank account, and you use it to supplement your income. Maybe you’ll go out for a nice dinner more often. Or, maybe you use the extra funds to finally upgrade your kitchen.

Then tax season comes. And it hits you: Instead of getting a 3 or 4-figure tax refund, you owe 4 or 5-figures. How are you going to pay your tax bill?

This story is a story of someone with a very expensive hobby not a business, my friend. And with just a few side projects, you’ve put yourself in a personal income pickle for the next 1-2 years paying back taxes to the IRS in monthly payments or putting the tax bill on your credit card.

(And those IRS payments are all being made with post-tax dollars of your personal income!)

There’s a better way to do this.

First, you need to file your freelance income as a business. Separating your freelance income from your personal income is the best way to ensure you’ve protected your personal assets and can realize a sustainable profit for your freelance business. To get started, you just need to figure out which business type makes the most sense for you.

What Is the Difference Between an LLC and S Corporation?

Let’s start by defining these two common business entity types:

A limited liability company (LLC) protects the individual owners and their personal assets from any losses, debts, or liabilities incurred by the company. An LLC also helps protect the owners from double taxation, since all business income is filed through their personal income taxes.

An S Corporation (S-Corp) balances the double-taxation protection of a limited partnership with passing on business income profits and losses to shareholders. The IRS has stricter guidelines for this type of business entity for both incorporation and operation of the business.

Picture of Taxes

How you register your business impacts not only your tax filings each year, but it will also play a large role in how you operate your business day-to-day. From how you invoice and receive payments from customers to how you pay for business services and employees, choosing the right business type has many factors to consider.

Exercise: Make a Pros and Cons List

When it comes to choosing the best type of business for your own work, it can be difficult to decide what’s best for you. Freelancing may not feel like a business to you yet, but it should. Of course, once you separate your freelance income from your personal income, it’ll start to feel like a business and the rest will fall into place.

This step is crucial. So, we’ve done some of the work for you by weighing key features of an LLC vs. an S-Corp to help you decide:

  LLC S Corp.
Separate from owners’ personal income X X
Annual tax filing required X X
Self-employment tax required X  
Documentation and process requirements
for shareholders, stock, company operations
Best with Passive Investors   X
Restrictions on eligibility   X
Protection from double taxation X X

Once you’ve decided and registered your business with your state, you will need to track your income and expenses accordingly.

Filing Freelance Income as a Business: Final Thoughts

  • As more freelance work is available and the traditional 9 to 5 begins to shift, gig workers need to protect their freelance income and run their side hustles as businesses. Determining what type of business entity to form involved many factors, including how you pay employees, accept payment from customers, and file both your personal and business taxes each year.
  • An LLC or S Corporation are common business types for small businesses and freelancers. With a few things in common, each business type has various pros and cons to weigh when considering which entity is right for your business.
  • Whether you design graphics from a home office or install hardwood floors for a family friend, tracking your freelance income and expenses like a business will help you maximize your profits and protect your personal assets.
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