3 BIG Non-Tax Reasons Freelancers and Independent Contractors Need an LLC

When I talk with freelancers and independent contractors about entities and how to structure their businesses, the discussion usually revolves around the tax consequences and how to save money. BUT! There are some big advantages of operating as an S corp (LLC taxed as an S corp) that aren’t related to taxes. Let’s take a look at a few here:

1. Bank Financing

Generally, if you operate a business as a sole proprietor, banks don’t want to lend you money for big ticket items (e.g., home, car, etc). They think that your income is too unstable and they want to see two years of profits from your business to even consider you. But, there’s a loophole!

If the same sole proprietor sets up an LLC and then elects to be taxed as an s corp, the S corp will be required to pay its owner a salary. So, the same sole proprietor will now receive a paycheck with paystubs and a W-2 just as though they worked for a big company. So now, the bank won’t look on your income as an unstable source, they will look at you like any other chump with a job. It works.

2. Unemployment Insurance
We all want our jobs to have great benefits including health, dental, 401ks, etc. You never want to use it, but employees also have the benefit of unemployment insurance from their company. Freelancers and independent contractors are not so lucky because they don’t have an employer paying for unemployment insurance. Again, the S corp fixes this (for some).

In many (not all) states, if a freelancer or independent contractor makes themselves an employee of their S corp, they can “fire” themselves if things go bad and they can actually take unemployment from the state. Let’s look at an example: Jane works as a real estate agent for brokerage XYZ. Jane has an LLC called JaneCo LLC and her advisors elect to have it treated as an S corp by filing Form 2553 with the IRS. She will be an employee of the S corp and pay herself a reasonable salary. A year later, she decides she wants to take a break. She has JaneCo LLC “fire” her and she stops receiving the paycheck. She can now contact her state and collect unemployment. This is a big deal for freelancers who feel their income isn’t very stable.

3. Liability Protection

We saved the best for last. So let’s assume that you’re a dentist. You’ve done a ton of work and jumped through hundreds (if not thousands) of hoops to get to where you are. You decide to work for another dentist who owns a few offices and he’s going to pay you a fixed amount, but he’s paying you as an independent contractor. This is a very common approach.

If you’re operating as a sole proprietor without an entity, you’re making a huge mistake. If it was 2008 in the middle of the financial crisis and your credit was destroyed, creditors could go after your income as a sole proprietor because you have no entity protection. However, with an entity, (preferably an LLC taxed as an S corp), you can have a level of protection from creditors. You can even take it a step further and open an LLC in Nevada or Wyoming and take advantage of the charging order. This makes it very difficult for creditors to get your money. Many attorneys who work on contingency won’t even take a case if they find out that you have an entity because it’s not worth their effort.

Clearly, there are lots of benefits to why independent contractors need an LLC (or freelancers). There are tons of tax benefits not discussed in this post, and equally persuasive non-tax benefits.

For information about S Corp vs Sole Proprietorship, click here.

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Tags: CPA firms for freelancers, IC as LLC, Independent Contractors, tax consultants for freelancers