Can a Freelancer Gain Tax Benefits with an LLC?

Managing finances and taxes is one of the trickiest parts of being a freelancer. Without the support of an employer to handle important matters like deductions, you're responsible for your financial well-being.

Once your income grows, you'll have to find a way to reduce your taxes and increase your savings.

One solution often recommended to freelancers is forming limited liability companies (LLCs). These entities are primarily known for their pass-through tax status, which can help significantly lower their tax bill.

But do freelancers need LLCs to get tax benefits? Find out below.

Understanding Freelancer Taxes

The Internal Revenue Service considers freelancers self-employed, meaning they must pay self-employment taxes. These taxes include Social Security and Medicare, totaling a 15.3% tax rate.

Self-employment tax is typically divided between the employee and the employer. However, since freelancers assume the role of both, they must pay the entire rate themselves.

This can be quite the burden for new freelancers since 15.3% is significantly higher than employees typically pay. More importantly, it can significantly reduce their take-home income and make it more difficult to obtain benefits like retirement plans, which the employer typically sponsors.

But on the bright side, freelancers like you are entitled to tax benefits. You can claim the deductions below to reduce your self-employment taxes:

• Retirement plan contributions deduction: Any contributions to self-employed retirement plans, like SEP-IRAS, are tax deductible.
• Self-employment tax deduction: Although you must pay the employer portion of the self-employment taxes, the IRS treats them as a business expense and considers them tax deductible.
• Home office deduction: If you work from home, you can deduct the cost of any workspace in your home that you use regularly for business.
• Health insurance premiums deduction: You can deduct the cost of your health insurance premiums, including dental and long-term care (LTC) insurance, from your taxes.
• Internet and phone bill deduction: Freelancers can deduct a portion of their phone and internet expenses that they use for business.
• Meals deduction: Any meals you purchase when traveling for business or entertaining a client can be deducted from your tax bill. However, entertainment expenses are not tax deductible.
• Travel deduction: Business trips that last longer than an ordinary workday are tax deductible.
• Vehicle-use deduction: You may also deduct a portion of the expenses associated with your vehicle that you've used for business.
• Interest deduction: If you took out a loan for your freelance business, you can deduct the interest you've paid from your taxes.

Do Freelancers Need LLCs to Get Tax Benefits?

Some might ask, “Do I need an LLC to freelance?” Definitely not. You also don’t need an LLC to reap the tax benefits offered to freelancers. You can claim the tax deductions listed above regardless of whether you operate as a sole proprietor or an LLC.

But if you want to maximize your freelance tax benefits, consider forming one.

What is A Limited Liability Company (LLC)?

Limited liability companies (LLCs) are legal entities separate from their owner. They offer limited liability, which protects their owners' assets from any debt or lawsuit the business incurs.

By default, LLCs have pass-through tax status, meaning they do not pay income taxes. Instead, everything they earn and lose is passed through to their owners, who will report these amounts on their personal tax returns.

However, they can change their tax status to a C or S corporation if needed. This flexibility is one of the primary reasons why LLCs are perfect for freelancers.

An LLC will shield your assets from any liabilities your freelance business faces, providing a sense of security. More importantly, it can help you reduce your self-employment taxes by electing to be taxed as a corporation.

Sole Proprietorships vs. LLCs: Which is Better?

Recent statistics show that over 80% of freelancers are sole proprietors, but this doesn't necessarily mean it's the best structure for everyone.

Sole proprietorships are simple and easy to form; they're the default entity you'll get when you start your freelancing journey. However, they don't have the same tax advantages as LLCs.

Sure, sole proprietorships also have pass-through tax status, but they can't change their tax election as LLCs do. You will likely pay more taxes as a sole proprietor once your business grows and your profit increases.

Meanwhile, when you structure your business as an LLC, you can change your tax election if you feel you've outgrown the pass-through status. One tax election that has proven effective for reducing taxes is the S corporation designation.

The S corp status will allow you to reduce your self-employment taxes by splitting your income into two parts: a reasonable salary and distributions. By making yourself an employee and giving yourself a salary, you only have to pay the employee portion of your self-employment taxes.

Any distributions you receive from the company will only be subjected to income taxes if your state has them.

But before you can enjoy these tax benefits, you want to ensure your LLC is eligible for the S corp designation. According to the "S" subchapter of the Internal Revenue Code, an LLC will only be granted the S corp status if it meets the following criteria:

• It must be a domestic entity.
• It must have no more than 100 shareholders.
• It must have only the allowable shareholders (i.e., individuals, estates, and certain trusts).
• It must have only one class of stock.
• It must not be an ineligible corporation (i.e., certain financial institutions, insurance companies, and domestic international sales corporations).

If your LLC meets these requirements, it's eligible for the S corp tax election.

Form An LLC For Freelancers Today

Ultimately, freelancers don't need LLCs to achieve tax benefits. But to maximize these benefits, consider establishing one with NCH's help.

NCH specializes in LLC formation for maximum tax savings. Our business formation specialists will assist you in forming an LLC tailored to your specific needs and goals. We'll guide you through the entire process, from choosing a unique name to designating a reliable registered agent.

NCH will ensure that your freelanceR LLC is poised for success. To learn more about our formation services, visit our website here or call us at 1-800-508-1729 to schedule a free consultation with one of our business formation specialists.

Disclaimer: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.