Freelancers: Should You Incorporate?
So, you want to hop aboard the Gig Economy train and make some extra dough — or maybe earn a lucrative living — as a freelancer, do you? Well, before you start cashing the checks, you should step back and decide if you should incorporate your business. To help you make this important decision, here are some things to keep in mind:
Personal Asset Protection
The chief benefit of incorporating is that if your business is held accountable for losses, debts, negligence or wrongdoing, then your personal assets are (with some exceptions) shielded from creditors and legal judgements. For example, if you are a freelance wedding planner and due to your negligence the bride and groom experience a fiasco instead of festivities, then your personal wealth or property may be at risk if the matter heads to court and you come out on the wrong side of a lawsuit.
However, it’s important to keep in mind that this protection is not absolute. You can (and probably) will get sued and be found personally liable if, through your business operations, you: personally and directly injure someone, do something deliberately fraudulent or illegal, fail to deposit taxes that you withhold from employee wages, personally guarantee a bank loan or debt on which your business defaults, or treat your business as an extension of your personal affairs.
More Tax Options
Incorporating also allows you to decide whether you want your business to be taxed as a corporation, a partnership (multi-member LLC), or a sole proprietorship (single-member LLC). This may (and likely will) reduce your overall tax obligation, plus in the case of incorporation, you will be able to separate your personal tax return from your business tax return. For example, if you are a car restoration wizard, then all of your expenses related to the cost of restoring a car (e.g. parts, equipment, shipping, etc.) would be captured in your business tax returns, and not your personal tax return.
More Perceived Credibility
Some customers feel more comfortable working with an incorporated business than an unincorporated one. Frankly, this distinction is not necessarily the case in reality: there are good incorporated businesses and bad ones, just as there are good unincorporated businesses and bad ones. However, perceptions make a difference, and you may find that your pitches and proposals get more traction if there is an “LLC” “Inc.” or “Corp.” after your business name.
When you incorporate, your business becomes a separate entity that is separate from your personal profile. This can make it significantly easier for you to get bank loans. Plus, you will be able to sell equity in your business to investors.
Drawbacks of Incorporating
Based on the above, incorporating your freelance operation seems like a no brainer, right? Well, not quite. There are some drawbacks to consider as well, including:
- Incorporating a business is time consuming, and there are setup and filing expenses.
- You will have to file (or more likely pay an accountant to file) two tax returns each year: one for you personally, and one for your business.
- There is a significantly greater paperwork burden for incorporated businesses. For example, you need to keep detailed books, create reports, maintain a share register, and so on. Many freelancers outsource this to a qualified bookkeeper or accountant, which is certainly more efficient, but obviously comes at a cost.
- Protection from personal liability is not absolute (as described above).
The Bottom Line
So, should you incorporate or not incorporate? Generally, most experts say that it’s wise to incorporate, provided that there is enough activity to justify the extra cost and administrative burden. Your best move is to speak with qualified business experts who do not have a vested financial interest in whether you incorporate or not. It’s an important decision, and one that you shouldn’t rush into, or make based on flawed assumptions or inaccurate information.