If you’ve decided to be a freelance artist or developer, you might be wondering to yourself if it’s worth setting up an LLC or corporation. What are the pros? What are the cons? You’ve probably heard lots of people talking about but maybe it seems like a lot of work? In this post, I’ll describe in plain English the 2 main reasons you should consider setting up a business for your creative development practice.
I’m not a lawyer or an accountant. This is personal knowledge from my experiences. Always get professional legal and financial advice before making any life choices.
One of the most important parts of an LLC or corporation is the concept of limited liability. The first 2 letters of LLC are also Limited Liability…that’s how important it is! It’s revolves around the fact that companies are individual entities of their own in the eyes of the law. That means your company is almost like a different person altogether that is separate from you in legal matters. This means that if something bad ever happens to the company, the liability is limited to the company and doesn’t involve you personally.
Limited liability is something I find to be pretty important in our industry, where we often work with crazy types of technology usually in spaces surrounded by people. It’s not out of the question that something goes wrong and someone gets hurt. The last thing you’d want is someone to come and take you to court for damages and losses. Now a company won’t prevent you from being sued, BUT it creates a separation between your personal assets and your company assets. So that means that when that person gets hurt, they wouldn’t be able to come and sue you (the person), take your house, and drain your personal bank account. They would have to sue the company and they can only take the company itself to court. Now they could even win in court and fully bankrupt the company but then (in most cases) they couldn’t come after your own personal belongings (house/car/savings/assets/etc). That’s the power of limited liability. The liability of your work is limited to the corporate entity and not you as an individual. So that’s a pretty big thing on it’s own.
Both LLC and S-corps and C-corps offer you that limited liability in the US, corporations in Canada have similar, and there are similarly functioning corporate entities in almost every country in the world.
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Second thing is tax optimization. Hooray! Sounds fun! Right????? Don’t worry, it’s not hard to get a general understanding of this and in most cases you’d have an accountant help you with the fine details for filing your taxes.
As an individual when you fill out your taxes there are certain things you can “write off” which is just a way to say you can legally count as it as an expense against your income. This means at the end of your taxes, you generally pay less to the government if your expenses are high and getting close to (or passing) the amount of your income, because you’re generally taxed based on how much money you have left after your expenses.
Now an individual person is only able to expense certain things. A business/corporate entity is able to expense a lot more things. You can see where this is going? A company basically can give you more opportunities to write off the things you’re buying/paying for against your income. That first step of tax optimization means that you’re almost always reporting lower amounts of left over money (profits) with a company than you would be able to as an individual. This applies to all kinds of company structures, including even things like Sole Proprietorship, which I don’t generally recommend.
The second part of tax optimization comes in the form of corporate tax rates vs personal tax rates. Corporate tax rates are generally lower than individual tax rates. That means that if you make $10,000 profit from a project you worked on, after taxes the corporate entity would actually have more cash remaining in the bank than you personally would if you put that $10,000 profit in your name.
Now I have to disclaimer right here that money in a company doesn’t mean that money is yours. Remember, corporate entities are almost like different people in the eyes of the law. If you use a company bank account like your personal bank account it can get you in serious trouble to the point of allowing people to sue you (the person) even through the limited liability shield! To make that money actually yours, you have to either pay yourself a salary or take a dividend pay out (basically a pay out to the owner/shareholders of the corporation). Then the money is yours and you can do whatever you like. Cool?
Your company would pay less taxes on the same amount of money compared to you. A lot of money we’re paid for project work also goes back into buying things for work. What you then can do is have the company buy the gear (again, more expenses to write off!!) and then whatever is left sitting in the company will have a lower tax rate than if it was sitting in your personal bank account.
It’s not uncommon for company founders to just give themselves a very minimal amounts of salary and keep most of their profits inside the company. The reason you’d still want to have a salary, even if absolutely minimal, is that it helps create a record of employment that can be incredibly important later in your career/life when you want to get a loan from the bank for a house or a car or similar. No record of employment / consistent salary == no loan from the bank.
So tl:dr: you get to claim more expenses, reduce your taxable income (aka profits), and decide how much you pay yourself and how much you keep in the company to take advantage of lower tax rates meaning you keep more of the money you make.
LLC is generally a good way to start business in the US because the whole purpose of it’s creation was to give small businesses/entrepreneurs the benefits of corporations but with less paperwork and less costs to upkeep. If later on you grow enough where you want to transition to a corporation for the purposes of managing shares, you can fill out paperwork to go from LLC to corporation.
In Canada, we don’t really have something like LLC, you have to go for a full on corporation, as sole proprietorship doesn’t offer limited liability. In either case, there are lots of services that can help make it easy to setup corporations for a few hundred dollars.
Whether you consider yourself an entrepreneur or not, knowing about some basics of business and setting up a business for yourself can have tons of benefits. I only named the two big ones of limited liability and tax optimizations as they’re in the originating DNA of companies, but even those can bring both immediate and long term benefits to you. Enjoy!