Self Employed vs LLC – Legal & Tax Advantages of an LLC for Sole Proprietors & Ind. Contractors
Self-employed can take advantage of working under an LLC. There are legal, tax, and growth advantages for sole proprietors to open an LLC. Most of the time, independent contractors can benefit from forming an LLC and get better personal liability protection.
Steps to Form an LLC
- Choose a name for your LLC.
- File Articles of Organization.
- Choose a registered agent.
- Decide on member vs. manager management.
- Create an LLC operating agreement.
- Comply with other tax and regulatory requirements.
- File annual reports.
- Out of state LLC registration.
This video is intended for educational purposes and should not be taken as legal or tax advice. You should consult with your financial professionals about your unique financial situation before acting on anything discussed in these videos. Freedomtax Accounting and Multiservices Inc. are providing educational content to help small business owners become more aware of certain issues and topics, but we cannot give blanket advice to a broad audience. Freedomtax Accounting and Multiservices Inc. or its members cannot be held liable for any use or misuse of this content.
If you’re self-employed or an independent contractor, and you’re wondering if you should be working under an LLC. In this video, we’re going to show you the three main advantages that self-employed individuals have by working under an LLC. That’s what we’re going to talk about in this video.
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Now basically, we get a lot of self-employed individuals and independent contractors calling Freedom Tax Accounting, and asking if they should be working under an LLC. And the correct answer is, maybe because every case is different. So, we always recommend that you do take a consultation with a legal professional, right tax professional to study your specific case, and see if in your case, it is better for you to be working under an LLC. Okay, but in this video, basically, we are going to show you the three main advantages that self-employed people get by working under an LLC. And once again, we always recommend that you take a consultation to study your specific case, because this is general information, but you want to make sure that working under an LLC is a benefit in your specific case. This is our contact information. And we do provide that consultation so you can contact us and schedule your initial consultation, and we will gladly evaluate your case and see if your self-employed business is better off working under an LLC.
Now, the LLC advantages for self-employed can be divided in three parts; legal advantages, tax advantages and growth advantages.
Let’s go to the first one, let’s talk about the legal advantages of working under an LLC. Now, if you’re self-employed, or an independent contractor, you have no personal liability protection. So, what does that mean? That your assets are not protected from business debt and claims because remember, you are the one providing the service Everything is under your name, everything is under your social security number. So, God forbid there’s an accident or something goes wrong in the service you’re providing or your business, then now you are personally liable for that claim or that. So that means that your personal home is at risk. Your personal credit cards are at risk. Your personal bank accounts are at risk, your all your assets. If you own cars, if you own properties, everything is at risk, because you are the one providing the service and that claim or the debt, everything is under your name.
Now, when you work as an LLC, even though you are the owner of the LLC, you are protected from personal liability from business debts and claims. So, basically the LLC protects your personal assets from being seized. Why? Because even though you are the owner of the LLC, and you’re the one providing the service, legally you’re not providing the service, it is your LLC that is providing the service and the LLC is a separate legal entity. So, if you are working under an LLC, and God forbid there’s an accident or something goes wrong with your product, if there is a lawsuit against you, it’s against the LLC; it is not against you. So, your personal assets are protected. Your personal money, your personal property, your personal bank accounts, your personal automobiles, all of that is protected because the LLC gives you a level of protection between you and the business. And there’s also legal protection the other way around.
Under the LLC, the LLC is also protected from you, because a lot of people talk about that if something happens in the LLC, your personal assets are protected but also the legal put action is the other way around, meaning that if something happens to you, then the LLC is protected. Okay, let’s say that your LLC grows, you have a big business, but now you get into personal trouble, and there’s a lawsuit against you as a person, then your business is protected from you. So, protection goes both ways. Okay, so that’s the legal advantage of the LLC.
Now, the second type of advantage to work under an LLC is for tax purposes, okay, why? Right now, if you’re self-employed, the IRS sees you as a sole proprietor. Okay, so you’re self-employed, and you file taxes as a sole proprietor meaning that you file taxes under the Schedule C, or you file taxes under Schedule E if you have rental properties, okay, because rental income is reported on Schedule E, but all your other active income as self-employed is reported under Schedule C. Okay.
Now, every income that you report on schedule C as a sole proprietor, the net profit of your business pays self-employment tax. Okay, that’s 15.3% of self-employment tax, plus the federal tax. So let me show you how that works. So right now, if you’re self-employed, independent contractor, remember that the IRS sees you as a sole proprietor. So how does that work? Okay, so sole proprietors file, Schedule C, or Schedule E, all the income from your business, this is your income, and you have all your deductions and expenses during the year. At the end of the year, you have your net profit or your net loss, okay. Now, this is the Schedule C, and this is your personal tax return, okay. This net profit gets reported under your personal income tax return, okay. And from this net profit is going to pay federal tax which starts at 10%. Because now it is subject to personal tax rate. So, the personal tax table. So, depending on your household income, this will affect the amount of federal taxes that you pay, but it starts at 10%. Plus, you pay self-employment tax, which is an additional 15.3%. Okay, here is social security and Medicaid. So, you pay at least 25.3% in taxes, that’s how sole proprietors pay taxes on their business. Okay, now remember this word sole proprietor, okay.
Now, this is the advantage of the LLC. Because the LLC- let’s go back if you’re self-employed, this is the only way you pay taxes; you have no other options. If you’re a self-employed, independent contractor, you file taxes on their schedule C or Schedule E. And this is how you file taxes. But under the LLC, you have a lot more options that depending on how your business grows, and your net profit, then you have options on how your LLC pays taxes that you can take advantage of a lot of tax advantages. Okay, let me show you. This is the LLC. When you open up an LLC with one owner, the IRS says that it files taxes as a sole proprietor, so you file taxes under Schedule C or Schedule E, which is the same thing, which you are doing right now, as a self-employed individual as an independent contractor. You will file taxes as a sole proprietor. So, if you are a single member LLC, the automatic designation for taxes from the IRS is the same way you’re filing taxes now, so if you’re a single member LLC, you get the legal advantage, but the automatic designation is that you’re going to file taxes the same way that you’re doing right now, the difference is, if you’re self-employed or independent contractor, you have no other options, you will always have to file as a sole proprietor.
Now, under the LLC, once your business grows and you’re making higher net profit, then you have the option of telling the IRS that you want your LLC to file taxes as an S-corp, under form 1120s, or as a C Corp, under form 1120, that once your business is making higher income, then these two forms are better than the Schedule C for tax purposes. Okay. Also, if you open up an LLC with two or more owners, the automatic designation for taxes is that you need to file a form 1065 as a partnership, but you also have the option of converting it to an S-corp, or a C Corp. So basically, under an LLC, your LLC can file taxes as Schedule C, Schedule E 1120s, 1120, or 1065. So, your LLC can file taxes one to five different ways. So, depending on how your business is growing, how much income and is making, what type of income it makes, how much net profit it has, at the end of the year, you can choose a better tax structure than the Schedule C for your business and save a lot in taxes. So that’s basically the tax advantage of the LLC, is that you’re not stuck just with the Schedule C, you have different options moving forward.
Okay, now, if you want to know how each tax structure works for LLC, we did a video in the past called five ways an LLC can file taxes, we go into detail and we show you one of the five ways that an LLC can file taxes and how that affects your tax returns. Okay, so this is a very good video that we suggest that you look in our channel, okay.
Now, the third way an LLC can be an advantage is that it will help you grow your business. Why? The LLC gives you a more professional image is not the same thing that you go to a client saying that you’re self-employed than telling that prospect of a client that you have an LLC, that gives you a more professional image that can lead to getting better, bigger job contracts. Actually, we do know the absurd and examples of independent contractors who come to our office that they need to open up an LLC in order to get a bigger contract. Because big businesses do business with other businesses, they usually do not hire or give contracts to self-employed or independent contractors. Okay, so it opens up more opportunities for your business because now you’re working under your company under your LLC, okay, and it makes you look more professional. Also, if you’re looking for financing options with a bank most likely will prefer to give a commercial loan to an LLC than to a self-employed individual. So, it opens up the door to grow your business faster. Okay.
Now, in conclusion, basically, for minimum additional fees a self-employed person can get from an LLC, personal liability protection, basically that the LLC is going to protect your personal assets. You have future tax advantages under the LLC, because depending on how your business grows, you have other options on how your LLC can file taxes and you’re not stuck with the Schedule C and you have bigger business opportunities because now you are portraying a better corporate image and you can get bigger contracts.
Now talking about minimum additional fees. Yes, to open up an LLC. There are some fees because you need to pay the LLC setup fees that depending on the state that you want the LLC, the fees are different. Every state has annual report fees every state every year, making LLCs pay them an annual fee to keep their company open. Every state is different. But there are certain states that are just like $30 a year, 50 bucks a year. Here in Florida, the LLCs pay 138 with change for the annual fee. There are some states that are a lot higher like Delaware which is like $300. But depending on your state, yes, there are annual fees that you need to pay. And in some cases, in some states, they make you pay other fees depending on the industry that you have. But even though you are paying higher fees during the year, to work under an LLC, then I think the LLC gives self-employed individuals a lot of advantages that I think it’s worth it.
But once again, this is general information. Every case is different. Talk to a legal advisor. Talk to your tax advisor. So, they can evaluate your case and they can properly advise if working under an LLC is the best option for your specific case. And once again, we do provide consultations. This is our contact information. And we are able to open up your LLC in any of the 50 US states.
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