If you are committed to growing your freelance career or small business, it’s wise to educated yourself on the pros and cons of incorporation. Incorporating your business is is the legal process used to form a corporate entity or company. While the term “corporation” might make you think of large scale, Fortune 500 businesses, it also applies to small business owners and sole proprietors (businesses owned by one person). The benefit of having a corporation is that is legally separates you, the owner, from your business, and you essentially become an employee of your business- paying yourself a salary from it. That means you have more tax and liability protections.
There are several types of incorporations. The first question to ask yourself is whether you want to incorporate as a partnership with one or more partners or individually as a sole proprietor of the business. Let’s take a close look at those two options:
According to the IRS, a Sole Proprietorship is an unincorporated business owned by one person. If you define your business as a sole proprietorship, you are not legally required to incorporate, however you do have the option to in order to separate yourself from your business when it comes to filing taxes and liability.
A general partnership is formed when two or more people agree to conduct business with one another, and to be personally liable for any legal or financial obligations the company may encounter. General proprietorships are not required to incorporate, but again, doing so can provide the tax benefits and greater legal protections against liability.
Once you decide to incorporate either with a partner or by yourself, there are several types of incorporation statuses to choose from based on your business needs. The two most popular statuses are:
LLCs protect the business owners’ personal assets from losses, company debts and legal rulings against the company (for example, if someone wants to sue you, they file the claim against the corporation and not you personally).
S Corporation (S Subchapter)
Similar to an LLC, an S corporation status also protects business owners’ personal assets and liability, and passes income (often in the form of dividends) to shareholders to avoid double corporate and personal taxation. In other words, there are considerable tax benefits since shareholders report income and losses on their individual tax returns and pay taxes at ordinary tax rates.
So, are you ready to incorporate and, if so, what type of structure is the best for you and your business? In order to figure that out, you need to closely work with an accountant you really trust. The answer is very individual to each business owner and business.
To get any idea of the process from a business owner’s perspective, we spoke to a WiseStamp user, Michelle Gevint, who recently decided to incorporate her NY photography business to an S-Corp with her husband, an industrial designer, as her partner in the corporation.
Hi Michelle, please tell us a bit about your business!
Sure! I’m a commercial photographer who serves several different types of clients and needs. I do food photography, events, fashion and more. I’ve been running my business for several years as a freelancer after getting my MFA in New York and recently decided to incorporate because my account said it would benefit both me and my husband, who is also a freelancer.
What type of incorporation did you choose and what were the benefits that enticed you to do it?
Because my husband and I both provide creative services and are freelancers, our accountant recommended forming a partnership as an S-Corp. We only changed our status about two months ago, so it’s too soon to feel the overall benefits, but it helps us calculate our taxes more precisely and protects us from liability. It’s a really complicated concept to understand, so we really relied on the advice and expertise of our accountant.
Our whole objective was to gain more stability. We feel that it’s giving us more clarification. So we know where we are as a household and not a surprise every time. Another reason why we did this was because of Social Security. You pay a lot in social security as a freelancer, but as an S-Corp, it lowers a bit.
What differences do you feel since incorporating?
Before I would earn checks, and have to estimate my own taxes. Now we have a corporate bank account and credit account. So it’s a whole different system of thinking. We are on our own payroll, so we are deducting the taxes. We feel less money coming in because of that, but we won’t have surprises—so that’s a clear benefit.
What’s your advice to other business owners who are thinking of incorporating?
First of all, be prepared for it to feel kind of daunting and overwhelming. I wish there was some sort of class that teaches freelancers how to do this! There’s a lot to learn, and it has a huge effect on your life in terms of how you handle your money and cashflow. Don’t expect to understand everything yourself when it comes to the legal and tax aspects. That’s why it’s important to make sure you have an accountant you trust.
To Sum Up
Incorporating your business is a big undertaking but can really help you scale your business and operate with more freedom and protection. However, it is a detailed legal process that requires the assistance of a seasoned professional. If you are thinking of taking this step, make sure to consult with your tax advisor, lawyer or accountant for their advice.