1 00:00:00,930 --> 00:00:03,600 All right. So let's go over the types of business entities 2 00:00:03,600 --> 00:00:07,160 available to you for the formation of your company in the United States. 3 00:00:07,160 --> 00:00:10,190 Now, for those of you who are watching but aren't in the United States, 4 00:00:10,190 --> 00:00:14,070 the business entities in your country aren't in my area of expertise, 5 00:00:14,070 --> 00:00:16,490 so I won't be covering them in this video. 6 00:00:16,490 --> 00:00:19,330 However, I've provided some resources in the notes below 7 00:00:19,330 --> 00:00:23,130 that should enable you to come to an educated decision on your own. 8 00:00:23,510 --> 00:00:25,860 For the different kinds of entities in the U.S., 9 00:00:25,860 --> 00:00:27,910 we won't go into detail on all the types 10 00:00:27,910 --> 00:00:31,120 because some aren't so relevant to running a freelance business, 11 00:00:31,120 --> 00:00:33,210 but we'll cover them, nonetheless. 12 00:00:33,210 --> 00:00:36,650 Now, the most basic business entity is a sole proprietorship. 13 00:00:37,220 --> 00:00:39,640 There is next to no paperwork to fill out, 14 00:00:39,640 --> 00:00:42,710 and most states recognize you as a sole proprietorship 15 00:00:42,710 --> 00:00:46,840 if you're conducting business, even if you don't think of yourself as one. 16 00:00:46,840 --> 00:00:49,970 In a sole proprietorship you, the owner, 17 00:00:49,970 --> 00:00:52,140 are responsible for all business transactions 18 00:00:52,140 --> 00:00:55,720 including any debts and liabilities owned by the business. 19 00:00:55,720 --> 00:00:58,630 Sole proprietorships exist as long as 20 00:00:58,630 --> 00:01:00,560 the owners are engaged in the business 21 00:01:00,560 --> 00:01:03,520 and can even pass on this business to their heirs. 22 00:01:03,520 --> 00:01:06,820 They also don't have to file any separate business taxes. 23 00:01:06,820 --> 00:01:09,240 All taxes on income earned by the business 24 00:01:09,240 --> 00:01:12,380 are filed along with the owner's personal tax returns. 25 00:01:12,380 --> 00:01:14,490 Sole proprietorships are quite simple, 26 00:01:14,490 --> 00:01:16,350 but they do offer a few advantages. 27 00:01:16,350 --> 00:01:19,480 You retain complete control of the business, of course, 28 00:01:19,480 --> 00:01:22,040 which is one of the reasons you got into freelancing. 29 00:01:22,040 --> 00:01:24,840 But as long as the company consists of only you, 30 00:01:24,840 --> 00:01:28,000 you'll have that advantage regardless of the company's structure. 31 00:01:28,000 --> 00:01:30,720 There are also very minimal costs associated with 32 00:01:30,720 --> 00:01:34,920 having a sole proprietorship and no corporate tax payments or fees involved. 33 00:01:35,570 --> 00:01:38,190 There are certainly downsides as well, though. 34 00:01:38,190 --> 00:01:40,410 Because all the money earned in the course of your business 35 00:01:40,410 --> 00:01:42,650 is filed with your personal tax returns, 36 00:01:42,650 --> 00:01:46,080 you will be paying self-employment taxes on that entire sum. 37 00:01:46,080 --> 00:01:50,460 On top of that, sole proprietorships don't offer any liability protection. 38 00:01:50,460 --> 00:01:55,410 If you run a freelance business, chances are you already are a sole proprietorship, 39 00:01:55,410 --> 00:01:58,210 but since it doesn't really offer much in the way of protection, 40 00:01:58,210 --> 00:02:01,600 and tax savings, we're going to look at some of the other entities. 41 00:02:02,260 --> 00:02:05,960 A partnership is another popular structure for small businesses, 42 00:02:05,960 --> 00:02:08,780 but it is one that's ideal for when two or more people 43 00:02:08,780 --> 00:02:10,710 go into business together. 44 00:02:10,710 --> 00:02:13,070 In our scenario, we're still solo freelancers, 45 00:02:13,070 --> 00:02:16,330 so partnerships don't fit in well with our model either. 46 00:02:16,740 --> 00:02:18,560 Then we have corporations. 47 00:02:18,560 --> 00:02:21,550 A corporation, in contrast to a sole proprietorship, 48 00:02:21,550 --> 00:02:24,690 is a business entity that is a completely separate entity 49 00:02:24,690 --> 00:02:27,020 from the owners of the company. 50 00:02:27,020 --> 00:02:30,050 It can have from one owner to an unlimited number of owners, 51 00:02:30,050 --> 00:02:32,990 who don't have to be involved with the running of the company. 52 00:02:32,990 --> 00:02:36,320 Corporations are separate taxable entities, 53 00:02:36,320 --> 00:02:39,080 which means that you as an owner or stockholder 54 00:02:39,080 --> 00:02:41,640 are entirely independent from the company. 55 00:02:41,640 --> 00:02:44,860 Corporations provide all the flexibility that you would need 56 00:02:44,860 --> 00:02:47,580 as a freelancer, but there is a downside. 57 00:02:47,580 --> 00:02:50,190 Corporations are the most expensive to set up, 58 00:02:50,190 --> 00:02:52,110 and the costliest to maintain. 59 00:02:52,110 --> 00:02:54,630 You also have all this unnecessary paperwork burden 60 00:02:54,630 --> 00:02:57,670 that you have to submit to the relevant authorities every year. 61 00:02:57,670 --> 00:03:01,870 That is unnecessary overhead for more flexibility than we would need. 62 00:03:01,870 --> 00:03:04,060 Remember, part of running your business 63 00:03:04,060 --> 00:03:07,110 is keeping those costs low whenever possible. 64 00:03:07,520 --> 00:03:09,620 Then we have LLCs. 65 00:03:09,620 --> 00:03:13,820 LLCs are a very popular choice of business entity for freelancers. 66 00:03:13,820 --> 00:03:17,140 LLCs are far simpler than corporations 67 00:03:17,140 --> 00:03:19,350 and are great for people looking to start a business 68 00:03:19,350 --> 00:03:22,250 with minimal hassle and fewer formalities. 69 00:03:22,250 --> 00:03:25,630 Similar to corporations, LLCs may have 70 00:03:25,630 --> 00:03:28,360 an unlimited number of owners, called members. 71 00:03:28,360 --> 00:03:32,260 LLC stands for limited liability corporation and, 72 00:03:32,260 --> 00:03:34,840 as you probably guessed, this means it offers 73 00:03:34,840 --> 00:03:38,210 the limited liability protection that corporations enjoy. 74 00:03:38,210 --> 00:03:43,260 In terms of taxes, LLCs are flow-through entities for tax purposes. 75 00:03:43,260 --> 00:03:46,910 This means that any taxable income earned by the company 76 00:03:46,910 --> 00:03:49,520 is passed on through to the individual members 77 00:03:49,520 --> 00:03:51,520 and is taxed only once. 78 00:03:51,520 --> 00:03:56,250 These taxes aren't distributed as wages but as a profit distribution. 79 00:03:56,250 --> 00:04:02,280 Unfortunately, in an LLC taxes are paid on any profit earned by the company. 80 00:04:02,280 --> 00:04:04,330 So, regardless of how much you take out 81 00:04:04,330 --> 00:04:06,340 as a profit distribution, 82 00:04:06,340 --> 00:04:09,940 you'll be paying taxes on the whole amount rather than just your share. 83 00:04:10,700 --> 00:04:13,910 The last structure we're going to look at is an S corporation. 84 00:04:13,910 --> 00:04:17,170 S corps, as they are commonly known, are corporations 85 00:04:17,170 --> 00:04:21,260 that elect to be taxed under the subchapter S specifications 86 00:04:21,260 --> 00:04:24,110 of the Internal Revenue Code of the IRS. 87 00:04:24,110 --> 00:04:28,020 This gives the corporation certain additional characteristics. 88 00:04:28,020 --> 00:04:30,350 Shareholders of an S corporation 89 00:04:30,350 --> 00:04:33,750 report the flow-through of income and losses 90 00:04:33,750 --> 00:04:35,760 on their personal tax returns 91 00:04:35,760 --> 00:04:39,420 and are assessed tax at their individual income tax rates 92 00:04:39,420 --> 00:04:42,310 instead of being taxed like a corporation. 93 00:04:42,310 --> 00:04:46,790 This allows S corps to avoid double taxation on their corporate income. 94 00:04:46,790 --> 00:04:49,810 In simple terms, the owners pay the taxes 95 00:04:49,810 --> 00:04:51,830 on the profits of an S corp. 96 00:04:51,830 --> 00:04:55,090 Unlike LLCs, however, the owners are only paying taxes 97 00:04:55,090 --> 00:04:57,220 on their share of the profits. 98 00:04:57,220 --> 00:05:00,810 An S corp is a subset of a regular corporation, 99 00:05:00,810 --> 00:05:04,360 and as a result offers the same limited liability protection 100 00:05:04,360 --> 00:05:07,550 that regular corporations do, thereby reducing the risk 101 00:05:07,550 --> 00:05:09,520 that the owners bear. 102 00:05:09,520 --> 00:05:12,800 In addition, S corps can lower what the company pays in taxes 103 00:05:12,800 --> 00:05:15,770 since you can pass the income through to the shareholders. 104 00:05:17,100 --> 00:05:19,540 S corps still have the paperwork burden, 105 00:05:19,540 --> 00:05:22,970 higher cost, and complexity of running a corporation, 106 00:05:22,970 --> 00:05:25,290 but they provide for a compelling business entity 107 00:05:25,290 --> 00:05:28,550 because of their tax advantages and liability protection. 108 00:05:29,160 --> 00:05:31,520 So, to summarize, we're going to go with either 109 00:05:31,520 --> 00:05:35,090 an LLC or an S corp for our freelance business. 110 00:05:35,090 --> 00:05:37,110 For you to make a decision regarding 111 00:05:37,110 --> 00:05:39,180 what structure you should pick between the two, 112 00:05:39,180 --> 00:05:41,550 you need to evaluate which one provides the best 113 00:05:41,550 --> 00:05:45,070 tax advantages for you in comparison to the cost of running it. 114 00:05:45,740 --> 00:05:48,500 This is where you talk to tax professional or an accountant. 115 00:05:49,150 --> 00:05:52,230 The laws vary from state to state, and it's probably best 116 00:05:52,230 --> 00:05:54,480 to let an expert advise you on this. 117 00:05:54,480 --> 00:05:58,070 Regardless of the choice, here's how you go about doing it. 118 00:05:58,960 --> 00:06:01,950 First you research the entity within your state or locale. 119 00:06:01,950 --> 00:06:04,920 The advantages and disadvantages I provided 120 00:06:04,920 --> 00:06:06,880 apply to the generic structures. 121 00:06:06,880 --> 00:06:09,480 Your state could have certain restrictions on some of these 122 00:06:09,480 --> 00:06:12,000 or have more benefits piled on. 123 00:06:12,000 --> 00:06:15,440 Make sure you understand what the entity means in your state. 124 00:06:16,210 --> 00:06:19,300 Talk to a tax professional about the tax benefits you get 125 00:06:19,300 --> 00:06:21,370 from creating that specific business entity 126 00:06:21,370 --> 00:06:23,690 versus any of the others. 127 00:06:23,690 --> 00:06:25,570 Fill out the paperwork. 128 00:06:25,570 --> 00:06:28,170 The traditional way to go about this is to go the state office 129 00:06:28,170 --> 00:06:29,870 and fill out any forms. 130 00:06:29,870 --> 00:06:32,040 There are plenty of solutions on the web, of course. 131 00:06:32,040 --> 00:06:34,660 Check out LegalZoom or BizFilings. 132 00:06:34,660 --> 00:06:38,150 It's relatively cheap and gets the job done with fewer hassles. 133 00:06:38,700 --> 00:06:42,200 Gather all the documents you need to apply for a business bank account. 134 00:06:42,200 --> 00:06:44,660 Remember, one of the reasons you created a company 135 00:06:44,660 --> 00:06:47,790 is to keep your personal and business finances separate. 136 00:06:47,790 --> 00:06:51,190 If you filed for an LLC, for example, the bank will ask you 137 00:06:51,190 --> 00:06:55,280 for your articles of organization and the operating agreement, at minimum. 138 00:06:56,410 --> 00:06:59,440 Once you have your company's structure and business bank accounts, 139 00:06:59,440 --> 00:07:03,170 you can go about doing everything as a company. 140 00:07:03,170 --> 00:07:05,980 You can issue and sign your contracts, invoice clients, 141 00:07:05,980 --> 00:07:08,930 and collect payments rather than as an individual. 142 00:07:09,480 --> 00:07:13,510 This provides a nice barrier of safety, allowing you to go about your business 143 00:07:13,510 --> 00:07:16,000 without worrying that you might lose your home.