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 the reasons 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 is the reason 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. 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. 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.
Don’t I have to incorporate to have an employee? No, a sole proprietor or a single member llc can have an employee. What remains true is that a sole proprietor or a single member llc does not pay a salary to the sole proprietor or the single member of the llc.
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. One year I did a comparison between incorporating an artist 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.
Some people incorporate so that they pay themselves a low salary. The result is lower Fica and Medicare costs. While this may save money in the short run, the amount you get in social security payments will be corresponding lower when it comes time to take payments. The IRS does not look kindly on your paying yourself below a reasonable compensation.
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. In the example given above where an artist netted $600,000 one year, his net in the succeeding years have been far below the $600,000 of the year we did the projection. Had he incorporated, he would have the additional work and costs involved with a corporation and very little savings, if at all.
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.
How does the Tax Cuts and Job Act of 2017 affect the question of if you should incorporate.
There is now a 20% qualified business income deduction for most freelancers. Those who previously incorporated to save themselves some money might now find that they have made a decision that may no longer hold true. However, one cannot switch back to Schedule C status easily because of new regulations restricting such a change.
One new group of freelancers may have to incorporate to get the benefit of the new 20% qualified business income deduction. Those are people who are not included in the specified service activity categories and who have taxable incomes above $207,500 if single or $415,000 can still take the deduction but you are limited to the greater of 50% of W-2 wages or 25% of the W-2 wages plus 2.5% of unadjusted basis of property.
Please see “Freelancers and the Tax Cuts and Job Act of 2017” for a more complete explanation.
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.