As a freelance consultant, there are hundreds of behind-the-scenes decisions that must be made to ensure your business is successful. One of the most daunting and frequently asked about questions are related to establishing and maintaining an LLC.
Our Head of Accounting, Joe Davis, has compiled a list of the 10 most frequently asked questions when establishing an LLC.
Q: What is an LLC?
A: LLC stands for Limited Liability Company. It’s a form of business entity where you get the protection of a corporation, with the easy maintenance and taxation of a sole proprietorship. This means in its base function, an LLC is a “pass-through” entity as far as taxes are concerned. So it provides legal protection, and doesn’t impact your taxes compared to a sole proprietorship. LLCs are based on state law, and thus have no automatic effect on your federal taxes, but do differ state-to-state.
Q: Do I need an LLC?
A: Your best advice will come from an attorney. We recommend LLCs because they offer liability protection, keep your business and personal activities separate, and give you some flexible options with taxes that can save you thousands when used correctly. This depends on your situation, and we recommend consulting a Mylance CPA or another tax professional to get the best advice for your situation.
Q: Okay, I’m sold. How do I get an LLC?
A: The easiest way is to use an online service provider. There are lots of sites to choose from, but we think Incfile is the best value and provides everything you need at a reasonable price. It’s also significantly less “upselly” than LegalZoom. If you’re someone who enjoys filling out forms and want to save a bit of cash, you can also register directly with the Secretary of State, and use the IRS website to get an EIN.
Q: What state should I use to register my LLC?
A: It depends on a few factors, but most of the time, you want to set up your LLC in the state where you live. Since LLCs are pass-through tax entities, 100% of your LLC’s profit will be taxed in your home state, so it makes sense to start there. If you set up your LLC in another state, you’ll need to register your LLC in your home state anyway, and often have more fees than if you just registered in your home state.
Q: What happens if I register my LLC in another state or I travel to other states for work?
A: If your LLC makes significant income from other states besides your home state, you may want to register with those states as a Foreign LLC. This process is often a legal requirement depending on the circumstances and each state’s laws. For example, California requires you to register with them if you make at least 25% of your income from in-state sources, no matter where you’re actually located. Compliance headaches aside, Foreign LLC registration can give your LLC privileges in the state that it wouldn’t have otherwise, so it can be beneficial when you meet the requirements.
Q: I read online that Wyoming, Delaware, and Nevada are the best states for LLCs. Shouldn’t I just register with one of them?
A: It’s true that those states have some of the most business-friendly laws in the country. But based on what we know about state tax law, it makes sense to use one of these states only if you live there, or if you don’t have a permanent residence in the US. Again, because of pass-through taxation, your LLC will have to be registered in your home state at some level. So any other state filings would just be extra paperwork and costs you don’t need.
Q: I’ve heard a lot about S-Corps and how they help you save on taxes. Should I set up my business as an S-Corp instead of an LLC?
A: It’s true that operating as an S-Corporation can help you save on taxes, but whether or not it actually will depends on several factors. While LLCs are based on state law, S-Corps are based on federal tax law. This means that your LLC can choose to be taxed as an S-Corporation using a process called “election.” As an elected S-Corp, your LLC will now split your freelance income into an owner’s salary and the remaining net profits (more on that later). When done correctly, it can save you thousands of dollars in self-employment tax each year. This is because whatever is not paid to yourself as a “salary” can be paid as a dividend or distribution, and those dividends or distributions are not subject to self-employment tax. Without an S-Corp, your entire net profit is subject to self-employment tax (15.3%). There are, however, additional administrative burdens of an S-Corp, so it pays to do some analysis with Mylance, or another tax professional, to make sure the benefits outweigh the costs.
Q: Do I need a business license?
A: Many counties and major cities in the US require some form of permit or license to operate a business. The rules are often enforced at a local level, so although the research can be tricky, the benefits of being properly licensed often outweigh the low costs of registration. Your best bet is to search online for your local city and county requirements, or to call these government agencies directly. San Francisco is a good example: they require a license for anyone doing business within city limits. Fees depend on the type of business and amount of income, and licensing is managed solely through the SF City Treasurer & Tax Collector’s office. Washington DC also requires businesses to obtain both a business license and home occupancy permit, and manages submissions directly through the District’s Department of Consumer and Regulatory Affairs. Major cities like these usually have information online, but smaller towns have licensing requirements too, so sometimes the only way to get registered is to call the local government and ask.
Q: Should I get a separate bank account for my business?
A: Yes. While not a legal requirement, we highly recommend separating your business and personal finances. Your books will be clean, your taxes will be easier, your personal assets will be safer, and you’ll have a clearer picture of how your business is doing. A true business bank account solidifies the separation of your business entity, and can help bolster the limited liability protections that your LLC provides. There are several great online banks to choose from, and others in the Mylance community will be happy to give their recommendations if you get stuck trying to decide.
Q: What about a separate credit card?
A: To the extent you can separate your personal and business finances, including expenses, you should. Thus, we recommend getting a business credit card to make this easier. However, this one is less of a deal breaker if you’re just starting out as a freelancer - you can track your business expenses on a spreadsheet, and can work with Mylance or your CPA to get it squared away once you get a business credit card and your accounting set up. If you do end up electing S-Corp status, having a separate credit card becomes a necessity due to the stringent tax reporting requirements of S-Corps.