When you start freelancing, one of the first business questions you may encounter is whether you should be a sole proprietor, form an LLC, or become an S corporation.
But those aren’t actually three versions of the same decision.
For most solo freelancers, there are 2 separate questions:
- How should your business be structured legally?
- How should your business be taxed?
Start Here: Sole Proprietor or LLC?
If you do business on your own without forming another type of business entity, you generally operate as a sole proprietor.
A sole proprietorship is simple to establish, but there is no legal separation between you and the business. Business income and expenses are generally reported on Schedule C of your individual federal income tax return.
A single-member limited liability company (LLC) creates a separate legal entity under state law and may provide some protection for your personal assets from business liabilities.
For federal income-tax purposes, however, a single-member LLC is generally treated like a sole proprietorship unless you elect a different tax classification. You will typically still report your business income and expenses on Schedule C.
When deciding whether an LLC makes sense, consider:
- Do you want legal separation between you and your business?
- Does your work create contractual, financial, or other liability concerns?
- Do clients expect or require you to operate through a business entity?
- What does your state charge to form and maintain an LLC?
- What ongoing filings or requirements will you have?
Where Does the S Corporation Come In?
An S corporation is a federal tax classification, not simply the next step after forming an LLC.
An eligible LLC can elect to be taxed as an S corporation. In other words, you can have an LLC that is taxed as an S corporation.
Should You Make an S-Corp Election?
Possibly—but this is a tax-planning decision.
An S-corp election may provide tax advantages in some circumstances, but it also adds requirements. If you perform services for your S corporation, the business generally must pay you reasonable compensation as wages before making non-wage distributions.
That can mean payroll, additional tax filings, recordkeeping, and administrative costs. Whether the potential tax advantages outweigh that complexity depends on your business income and individual tax situation.
Want a Short Version? Here’s a Decision Tree
This article provides general educational information and is not legal or tax advice.