Do I Need an LLC to Freelance?

Do freelancers need an LLC? That’s a question many solo professionals ask as they start and grow their small businesses. While freelancers aren’t legally obligated to form a Limited Liability Company, doing so offers some advantages over operating as a Sole Proprietorship.

In this article, I’ll touch on the difference between running a freelance business as a Sole Proprietorship vs. an LLC. I’ll also summarize what’s involved in creating a Limited Liability Company and answer some frequently asked questions about operating as a freelance LLC.

Sole Proprietorship vs. LLC

Most freelancers choose to operate as either a Sole Proprietorship or a single-member LLC (an LLC with one owner). Both business structures offer administrative simplicity compared to operating as a corporation. So, what’s the difference?

Sole Proprietorship Overview

A Sole Proprietorship is considered the same legal and tax-paying entity as its owner — there’s no separation; therefore, the owner’s personal assets are at risk if the business has financial or legal problems.

What about a sole proprietor’s tax responsibilities? The business gets taxed as a pass-through entity, with all profit and loss flowing through to the owner’s individual tax returns. In addition to paying income tax on profits, the sole proprietor must also pay self-employment taxes (Social Security and Medicare) on earnings. Self-employment taxes are akin to the FICA tax deducted from your paycheck when employed by someone else. Because sole proprietors do not receive a paycheck with income taxes and Social Security and Medicare tax withheld from their compensation, they must estimate their tax obligations quarterly and send estimated tax payments to the IRS and other tax authorities.

Forming a Sole Proprietorship requires no state registration paperwork. Basically, as soon as freelancers start doing business, they have established a Sole Proprietorship. However, they may have to file a DBA (Doing Business As) with the state or county if they want to market their business using a name that does not include their first and last name. For example, if Jenna Brown wishes to call her freelance writing business “Working Words” instead of something like “Jenna Brown Freelance Writing Services,” she would need to file a DBA to gain approval to use the fictitious name.

Depending on the state and local jurisdiction where a freelancer works, they may need to obtain certain business licenses or permits, too.

Sole proprietors pay themselves via owner’s draws (usually by writing themselves checks) from their business profits.

LLC Overview

When a freelancer forms a single-member LLC, they create a separate legal entity for their business. So their personal assets gain some protection against the debts of the Limited Liability Company. In many circumstances, the freelancer’s home, retirement accounts, vehicle, etc., will not be up for grabs in lawsuits or to settle debts. However, an individual’s negligence or intentional malpractice can put their personal assets at risk.

A freelance LLC is considered the same entity as the business owner for tax purposes. Like in a Sole Proprietorship, LLC taxes are handled on a pass-through basis. All profit and loss flow through to the owner’s personal tax returns, and the freelancer is responsible for reporting and paying their taxes.

However, LLCs have tax flexibility that Sole Proprietorships do not. An LLC that meets the IRS’s qualification criteria can elect for S Corporation tax treatment. With the S Corporation election, the freelancer pays themselves as a company employee through payroll rather than owner’s draws. The freelancer can then take the remaining profit as distributions. Because wages and salaries are subject to Social Security and Medicare taxes, but profit distributions are not, this may help the freelancer minimize their overall tax liability.

To create an LLC, the freelancer must file formation documents (Articles of Organization, sometimes called Certificate of Organization) with their state. The LLC’s registered business name may be fictitious (no DBA filing necessary). Depending on where the LLC is formed and operates, it may need to obtain business licenses or permits and fulfill some ongoing compliance tasks (such as filing an annual report).

How to Form an LLC for Your Freelance Business

The requirements vary depending on the state. Generally, most freelancers must take the following steps to start an LLC:

1. Decide what to call your LLC and do a business name search – Some freelancers include their first and last name in their LLC name, while others opt to register their business with a fictitious name. Business name search and trademark search tools are available help business owners confirm their name is not already registered by someone else.
2. Designate a registered agent – LLCs must provide their registered agent information in their formation paperwork. A registered agent is an individual or entity authorized to accept service of process and important government correspondence on behalf of the business.
3. File Articles of Organization – Articles of Organization are required to establish the LLC’s charter to operate legally in the state. Some states have other names for the form, such as the Certificate of Organization or Certificate of Formation.
4. Obtain an EIN – Freelancers forming an LLC will need an Employer Identification Number (EIN) from the IRS, even if they don’t have employees. Banks often ask freelancers to provide their EIN when setting up a business bank account. Freelancers may have to provide their EIN when establishing other business accounts. Sometimes, clients and vendors may ask for EIN information as well.
5. Open a business bank account – Freelancers should open a business bank account to separate their personal and business funds. Commingling funds (i.e., using business monies for personal purchases or vice versa) is a recipe for disaster. If the LLC gets sued or can’t pay its bills, a court could decide that the freelancer’s failure to keep finances separate pierces the corporate veil. That means the freelancer can lose their personal liability protection, putting their home, personal bank accounts, and other personal property at risk.
6. Research and apply for required business licenses – Freelance business license requirements vary. Some freelancers don’t need any license or permit, while others will need to obtain one from their state, city or county, or professional credentialing organization.
7. Prepare an LLC Operating Agreement – Even in a single-member LLC, it’s helpful to have an LLC operating agreement that defines how the business entity will be managed and what should happen to it in the event the freelancer becomes too ill to work, dies, or decides to close the business. A freelancer’s LLC operating agreement should be kept in a safe place at the principal place of business.

Freelancer FAQs

1. Do freelancers need a business license?

Business licenses for freelance work vary according to where the individual lives and what they do. States, counties, and municipalities may have licensing and permit requirements applicable to all types of businesses, including freelancers. And sometimes, license and permit requirements are specific to certain industries and lines of work.

Examples of potential freelance business license requirements:

• Sales tax permit
• General business license
• Zoning permit
• Professional license or certifications (for freelancers in professions such as cosmetology, accounting, architecture, health care, and engineering)

2. Do freelancers need an EIN?

Freelancers who operate as a Sole Proprietorship and hire employees or form an LLC (even if they don’t have employees) will need to obtain an EIN. An EIN is a federal tax ID number issued by the IRS. Banks and other financial institutions typically want to know a freelancer’s EIN before opening any accounts in the business’s name.

3. What freelance LLC taxes do freelancers have to pay?

Examples of common freelance tax responsibilities include income tax, Social Security and Medicare taxes, sales tax, and franchise tax.

Like other LLCs, a freelance LLC does not pay income taxes at the business level. By default, profit and loss flow through to the business owner’s personal tax returns, and income is taxed at the applicable individual tax rates. Note that some states do not levy a personal income tax.

In addition to federal, state, and local income tax (if applicable), freelancers pay self-employment taxes (Social Security and Medicare) on their business profits. Because no portion of the 12.4% Social Security and 2.9% Medicare tax burden is paid by an employer, the freelancer is responsible for the entire amount. Freelancers must estimate, report, and pay income and self-employment taxes quarterly.

If a freelancer elects to have their LLC taxed as an S Corporation, they might lower their self-employment tax burden. With S Corp status, the freelancer only pays Social Security and Medicare taxes on their wages and salaries from the business. The remaining profits taken as distributions are subject to income tax but not Social Security and Medicare taxes.

Other possible freelance taxes — such as sales tax or franchise tax — depend on the state and what types of services the freelancer provides.

4. What are the options for how to pay yourself from an LLC?

Freelancers who choose the default LLC tax treatment pay themselves via owner’s draws from their business profits. Most business owners do this by writing a business check to themselves so they can transfer funds to their personal account.

If a freelancer elects for S Corporation status, they must put themselves on their business’s payroll and pay themselves a reasonable wage or salary via a paycheck or direct deposit. Any remaining business profits are passed through (and taxed as) distributions to the freelancer.

5. Should freelancers form an LLC?

Whether you need an LLC as a freelancer depends on what you want for your business.

Consider the following questions when deciding on LLC formation:

• Do you want to protect your personal assets from the liabilities of your business? An LLC offers personal liability protection, while a Sole Proprietorship does not.
• Do you want some flexibility in how your business profits are taxed? An eligible LLC can elect to be treated as an S Corporation for tax purposes.
• Do you want to enhance the credibility of your freelance business? Some customers, potential project partners, and vendors may perceive a freelancer operating as a Sole Proprietorship as less reliable and responsible than one registered as an LLC.
• Do you anticipate eventually seeking funding to grow your freelance business? Lenders and investors are usually more likely to provide financial backing to an LLC than a Sole Proprietorship.

These are helpful talking points for thinking through if an LLC is right for a freelance business. But every freelancer’s situation is unique in some way. I encourage solo business owners to discuss their circumstances with a knowledgeable lawyer and accounting professional. Research and the expertise of expert resources are the keys to making an informed decision that will start your freelance business on the right foot and keep it stepping in the right direction.