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Sunday, January
31, 2010
Freelance Toolbox
Freelance Inc.
By
Bruce Shutan
You operate out of a corner of your house. A coffee shop is your
conference room. Should you turn yourself into a corporation?
I decided
at the end of 2006 to form 89 Peanuts Inc. (the name is an inside joke) with the
assistance of Tom Bartlett, a registered tax preparer and certified financial
planner with Royal Alliance Associates Inc. Bartlett told me incorporating makes
sense for anyone whose annual net profits exceed $25,000.
“It’s a way of
reducing the corporate income without reducing the personal income,” he said.
Some advantages of incorporating vs. staying a sole proprietor:
BIGGER IRA CONTRIBUTIONS
A sole proprietor can contribute up to $5,000, pretax, into an IRA, and as
much as 13.04 percent of net income into a simplified employee plan (SEP) or a
savings incentive match plan for employees (SIMPLE) IRA. But people who have
incorporated can salt away up to 25 percent of income, with a limit of $49,000
in 2009.
LOWER TAXES
A sole proprietor who earns $60,000 in a given year will pay about $9,500 in
Social Security taxes, but the amount is just $4,500 for an S corporation owner
who pays himself or herself $30,000 a year, and pays a state corporate income
tax.
CONSISTENT DEDUCTIONS
A monthly allowance tied to a percentage of gross income can be set up to pay
for automobile and entertainment expenses.
BETTER BENEFITS
Incorporating means being able to write off premiums for medical,
unemployment and life insurance, as well as file a claim against the corporation
for unemployment, since unemployment taxes are paid along with state payroll
taxes, based on the salary portion of one’s earnings.
It’s not necessary
to hire a lawyer to incorporate. Low-cost services such as LegalZoom.com can be
used to complete the necessary paperwork and receive a corporate seal from the
state where the corporate entity is established.
People who incorporate
must file either as an S corporation, C corporation, limited liability company
(LLC) or limited liability partnership (LLP). Bartlett says the decision hinges
on state corporate tax laws and the potential need for greater legal protection
(forming an LLC can lower liabilities).
Many freelancers opt to form S
corporations, which pay no federal corporate income tax.
All earnings go
directly to the corporation’s shareholders, even if it’s a sole shareholder, and
are reported on an individual’s income tax return. Bartlett says an S
corporation and LLC are not subject to Social Security taxes and issue K-1 forms
for profit distributions. C corporations pay wages and dividends. LLPs are
partnerships and not practical for a freelancer.
In order to avoid
penalties for under-withholding or underestimating quarterly tax payments,
corporate owners will need to pay in at least as much as their previous year’s
tax bill and can pay more based on projected net earnings. While this also is
true for sole proprietors, Bartlett points out that corporate income is often
omitted in estimating a new year’s total income.
Not all freelancers
will want to incorporate. Daniel Steven, a publishing attorney, cautioned in an
article on PublishLawyer.com that “incorporating also can be expensive and
ineffective.” The cost of incorporating can range from $25 to $100, depending on
miscellaneous state fees, according to Bartlett. But there could be other costs
and greater complexity for some prospective business owners. In my case, for
example, the initial tab was $820 when factoring in fees associated with
receiving legal assistance from LegalZoom.com, setting up a post office box in
an unincorporated area of Los Angeles to avoid also having to pay a city tax,
and having my initial corporate tax return prepared.
Steven also noted
that forming a C corporation, while useful for letting you pay yourself, also
forces you to withdraw profits as stock dividends. These face double taxation at
both a corporate and personal tax rate, while the IRS can force these business
owners to withdraw funds deemed excessive, pay a dividend tax and assess a
penalty — a scenario that’s avoided for S corporation owners.
“Most
freelance writers are usually better served worrying about finding new clients
or finishing the next book rather than incorporating,” Steven wrote.
But
for me, I’m more in control of my retirement plans and can earmark money for
these savings vehicles that otherwise would have gone into FICA taxes paid under
Social Security. At the same time, I’m insured for Social Security death
benefits and can receive unemployment insurance by paying into the system.
I have better legal protection. And I have the intangible advantage that
prospective clients may take me more seriously.
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