Ask an independent worker to define what it means to have freelance benefits. Odds are, you’ll hear a mix of snide or depressing responses. After all, as freelancers, we don’t have much bargaining power when it comes to pricing and acquiring benefits, like health insurance. Or do we?
How Is Your Business Set Up?
How you structure your independent business can make a difference in the type and cost of benefits you can acquire. Say you run an S corporation, like me. Paying less in overall tax is a boon, but my retirement account options are limited. If we chose to keep the business the size it is now — just my wife and I — we could take advantage of the Solo 401k.
Grow beyond that, and we’ll be limited to the SEP IRA, which is exclusively funded by business profit, or the SIMPLE IRA. The SIMPLE IRA costs a small fee to set up, but like the Solo 401k, it also allows for setting aside a portion of salary on top of business profit contributions. Consulting a tax advisor can help you decide the best trade-offs when it comes to affording benefits, like retirement.
In the meantime, here are four key questions to ask before deciding how to structure your business and what freelance benefits you can expect to yield as a result:
- Do you have a lot of assets that’d be at risk were your business sued?
- Are you a high-earner, generating more than six-figures of revenue from your independent business?
- Do you freelance as a side gig, or are you full-time?
- Do you mind paperwork and reporting?
If you answered yes to the first two questions, no to the fourth and freelance full-time, it’s probably time you looked into incorporating, if you haven’t already. For the rest, sole proprietorship is a perfectly acceptable business structure.
Measuring the Benefits of Sole Proprietorship
Setting up a sole proprietorship involves very little. Usually, you’ll name your business, register with the Secretary of State and get a business license, if you need one. You should also get a distinct business tax ID from the IRS to show you have a separate business. This number doesn’t need to change if you later decide to incorporate, reducing the amount of paperwork to upgrade.
Also, just because your business is synonymous with you, the IRS allows for recording all business and personal income on the same 1040 for filing annual tax returns. Just use Schedule C to report your revenue and expenses and move the totals, even if they’re losses, to the summary page. Simplicity is one of the biggest draws of sole proprietorship.
Just make sure not to fib: The IRS pays closer attention to high-earning sole proprietors when it comes time to pick returns to audit.
Why You Should Incorporate
My wife and I decided to incorporate in 2009, after seven years of sole proprietorship. Taxes took an increasing toll as our business grew, and we needed the relief provided by setting up a separate tax entity — despite the added paperwork. To this day, we pay a lower percentage of our overall earnings to taxes as a result of the change, though it’s still a big bite.
The downside? We decided to refinance our house that same year and ended up getting turned down. Incorporating reset the clock on our business in the eyes of the big bank underwriting the loan, and nothing less than two years of corporate history counted for proof of our ability to manage a mortgage at that point. Fortunately, waiting gave us time to find a better deal.
Design for the Freelance Benefits That Matter Most
Every situation is different. What you face as a freelance illustrator may be materially different from what your coworking neighbor faces as a freelance industrial engineer. Don’t assume you need to incorporate once you’ve been in business long enough or your earnings reach a certain level. Instead, think of the benefits that matter most to you, and then, consult a tax advisor to price out the cost of buying what you need.
Do it again next year and the year after that. The more you evaluate the cost and payoff of freelance benefits, the more likely it is you’ll get your money’s worth.