Should I Incorporate?
Many freelancers want to incorporate or think they want to incorporate. They then incorporate and find that they really didn’t examine if they should have incorporated in the first place. They chafe under the much stricter requirements for filing and for maintaining themselves on a payroll with all the extra costs of payroll taxes. Other freelancers have the belief that if they incorporated they could lower their taxes. Still others think they have to be incorporated to either be in business or to have an employee.
I would ask you what the reason is that you think you might want to incorporate.
You do not have to incorporate to be in business. You can be in business just by being paid for a service or a product. You are then a sole proprietor as well as a self-employed freelancer.
Don’t I have to be incorporated to protect myself? You should discuss the liability issue with an attorney. I would ask though what your fear is. If you have any reason to fear a liability issue, shouldn’t you carry the insurance now that would protect you if you were sued? You should have this insurance whether or not you’re incorporated. People forget that if they incorporate and they get sued, they still have to pay legal fees and they may still be liable.
An alternate structure to consider is to become a single member LLC. An LLC is a limited liability company. It is not normally a corporation. Ask an attorney if, in addition to insurance, you get liability protection with an LLC. If the answer is yes, wouldn’t it be simpler just to be an LLC?
With a single member LLC, on the federal level, your tax filings remain the same Schedule C that you’ve always filed on a 1040. In NYS, you have a yearly informational form with a small fee. With a corporation, you have to have a balanced set of books and file separate federal, state, and even city (if you work in NYC) corporation forms. Plus you still have to file your taxes as an individual. Additionally, you have to pay yourself on a W-2 and pay for payroll costs. What I have found is that corporations have exponentially more paper work than a simple Schedule C filing and that many people decide they aren’t worth it. They then have to unincorporate.
Doesn’t incorporating save money? I suspect it used to save money when health insurance and pension contributions weren’t 100% deductible which they are now. But for most freelancers it increases costs and aggravation. I used to think that it was worth it to incorporate someone in NYC if they netted $250,000 or more. This year I did a comparison between incorporating someone netting $600,000. I found that he would save $5,000 but he would have estate issues because of what would be included in his corporation. He decided against incorporating.
Don’t I have to be incorporated to have an employee? No, sole proprietors can have W-2 employees.
What is true is that corporations get audited less than Schedule C’s. The reality is that very few Schedule C’s get audited and the IRS is cracking down and increasing audits for corporations.
What is also true is that some freelancers, those in the entertainment business who get paid on W-2’s have to pay managers, agents, and attorney out of their W-2 income might benefit from incorporating. Those people often hit alternative minimum taxes. For them incorporating does save money. But even to them, I would recommend not incorporating until they’re sure to have saved at least $5000 a year for two or three years. Why? People unfortunately have a few good years but then don’t necessarily repeat. Once they’ve incorporated, they have to file the more intricate forms for corporations and they are costing themselves more when they don’t have the money to have the extra costs.
Another possibility where a corporation might save money is you and your family have very large yearly health costs.
If you want to have investors, then incorporating definitely might serve you. But then so might becoming a partnership serve you.
In my experience most freelancers do not have the conditions where a corporation serves them. Before you incorporate yourself on the internet, I would recommend that you consult both a tax preparer and an attorney about the various forms of business structures you have available to you. Each possibility has different advantages and disadvantages. Get the tax preparer to do a comparison between what filing as a corporation (be it an S-corporation or a C-corporation) would result in and what filing as a sole proprietor results in in terms of work, cost, and paperwork. Once you’ve really looked into changing your form of business from a Schedule C freelance business to something else, you have a basis to begin to make a choice.