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Not every business entity is appropriate for running a freelance business so let’s spend some time reviewing the pros and cons of a few business structures. With that information in hand, we will briefly go over the process of creating a company.
Forming Companies Outside the US
UK
Australia
Canada
France
To add additional countries to this list, please email me at pasan@teamtreehouse.com
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All right. So let's go over the types of business entities
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available to you for the formation of your company in the United States.
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Now, for those of you who are watching but aren't in the United States,
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the business entities in your country aren't in my area of expertise,
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so I won't be covering them in this video.
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However, I've provided some resources in the notes below
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that should enable you to come to an educated decision on your own.
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For the different kinds of entities in the U.S.,
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we won't go into detail on all the types
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because some aren't so relevant to running a freelance business,
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but we'll cover them, nonetheless.
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Now, the most basic business entity is a sole proprietorship.
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There is next to no paperwork to fill out,
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and most states recognize you as a sole proprietorship
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if you're conducting business, even if you don't think of yourself as one.
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In a sole proprietorship you, the owner,
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are responsible for all business transactions
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including any debts and liabilities owned by the business.
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Sole proprietorships exist as long as
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the owners are engaged in the business
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and can even pass on this business to their heirs.
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They also don't have to file any separate business taxes.
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All taxes on income earned by the business
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are filed along with the owner's personal tax returns.
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Sole proprietorships are quite simple,
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but they do offer a few advantages.
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You retain complete control of the business, of course,
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which is one of the reasons you got into freelancing.
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But as long as the company consists of only you,
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you'll have that advantage regardless of the company's structure.
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There are also very minimal costs associated with
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having a sole proprietorship and no corporate tax payments or fees involved.
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There are certainly downsides as well, though.
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Because all the money earned in the course of your business
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is filed with your personal tax returns,
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you will be paying self-employment taxes on that entire sum.
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On top of that, sole proprietorships don't offer any liability protection.
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If you run a freelance business, chances are you already are a sole proprietorship,
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but since it doesn't really offer much in the way of protection,
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and tax savings, we're going to look at some of the other entities.
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A partnership is another popular structure for small businesses,
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but it is one that's ideal for when two or more people
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go into business together.
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In our scenario, we're still solo freelancers,
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so partnerships don't fit in well with our model either.
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Then we have corporations.
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A corporation, in contrast to a sole proprietorship,
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is a business entity that is a completely separate entity
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from the owners of the company.
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It can have from one owner to an unlimited number of owners,
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who don't have to be involved with the running of the company.
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Corporations are separate taxable entities,
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which means that you as an owner or stockholder
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are entirely independent from the company.
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Corporations provide all the flexibility that you would need
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as a freelancer, but there is a downside.
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Corporations are the most expensive to set up,
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and the costliest to maintain.
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You also have all this unnecessary paperwork burden
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that you have to submit to the relevant authorities every year.
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That is unnecessary overhead for more flexibility than we would need.
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Remember, part of running your business
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is keeping those costs low whenever possible.
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Then we have LLCs.
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LLCs are a very popular choice of business entity for freelancers.
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LLCs are far simpler than corporations
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and are great for people looking to start a business
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with minimal hassle and fewer formalities.
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Similar to corporations, LLCs may have
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an unlimited number of owners, called members.
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LLC stands for limited liability corporation and,
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as you probably guessed, this means it offers
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the limited liability protection that corporations enjoy.
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In terms of taxes, LLCs are flow-through entities for tax purposes.
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This means that any taxable income earned by the company
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is passed on through to the individual members
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and is taxed only once.
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These taxes aren't distributed as wages but as a profit distribution.
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Unfortunately, in an LLC taxes are paid on any profit earned by the company.
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So, regardless of how much you take out
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as a profit distribution,
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you'll be paying taxes on the whole amount rather than just your share.
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The last structure we're going to look at is an S corporation.
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S corps, as they are commonly known, are corporations
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that elect to be taxed under the subchapter S specifications
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of the Internal Revenue Code of the IRS.
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This gives the corporation certain additional characteristics.
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Shareholders of an S corporation
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report the flow-through of income and losses
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on their personal tax returns
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and are assessed tax at their individual income tax rates
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instead of being taxed like a corporation.
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This allows S corps to avoid double taxation on their corporate income.
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In simple terms, the owners pay the taxes
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on the profits of an S corp.
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Unlike LLCs, however, the owners are only paying taxes
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on their share of the profits.
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An S corp is a subset of a regular corporation,
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and as a result offers the same limited liability protection
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that regular corporations do, thereby reducing the risk
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that the owners bear.
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In addition, S corps can lower what the company pays in taxes
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since you can pass the income through to the shareholders.
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S corps still have the paperwork burden,
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higher cost, and complexity of running a corporation,
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but they provide for a compelling business entity
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because of their tax advantages and liability protection.
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So, to summarize, we're going to go with either
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an LLC or an S corp for our freelance business.
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For you to make a decision regarding
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what structure you should pick between the two,
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you need to evaluate which one provides the best
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tax advantages for you in comparison to the cost of running it.
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This is where you talk to tax professional or an accountant.
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The laws vary from state to state, and it's probably best
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to let an expert advise you on this.
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Regardless of the choice, here's how you go about doing it.
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First you research the entity within your state or locale.
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The advantages and disadvantages I provided
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apply to the generic structures.
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Your state could have certain restrictions on some of these
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or have more benefits piled on.
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Make sure you understand what the entity means in your state.
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Talk to a tax professional about the tax benefits you get
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from creating that specific business entity
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versus any of the others.
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Fill out the paperwork.
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The traditional way to go about this is to go the state office
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and fill out any forms.
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There are plenty of solutions on the web, of course.
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Check out LegalZoom or BizFilings.
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It's relatively cheap and gets the job done with fewer hassles.
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Gather all the documents you need to apply for a business bank account.
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Remember, one of the reasons you created a company
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is to keep your personal and business finances separate.
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If you filed for an LLC, for example, the bank will ask you
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for your articles of organization and the operating agreement, at minimum.
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Once you have your company's structure and business bank accounts,
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you can go about doing everything as a company.
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You can issue and sign your contracts, invoice clients,
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and collect payments rather than as an individual.
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This provides a nice barrier of safety, allowing you to go about your business
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without worrying that you might lose your home.
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