When you are self-employed, you can choose to be a sole proprietor or create an LLC. Which option works best depends on your business needs.
A Limited Liability Company (LLC) and sole proprietorship differ in their tax requirements, financial liability, and establishment procedures.
Operating as a sole proprietorship
If you participate in freelance work, you automatically have a sole proprietorship. There is no specific paperwork or fees required to establish your business. Sole proprietorships only have one employee and you can start work immediately.
Sole proprietorships do not differentiate between individual and business taxes. You report all income and business expenses with your personal income taxes. Since both the employer and employee portion of the federal medical and retirement fund taxes are your responsibility, you pay the total amount as self-employment tax.
Creating an LLC
You can establish an LLC with yourself as the only employee. This is a single-member limited liability company. While you must pay fees and file legal documents to create the business, an LLC has limited liability which protects individuals from being responsible for business losses and lawsuits.
The Internal Revenue Service views a single-member LLC the same as a sole proprietorship. You report all income and loss as an individual.
However, an LLC also has the option of filing as a C Corporation. With this designation, the business pays corporate taxes on its net income that does not include your salary. Your income as an employee of the corporation requires you to pay federal taxes only on your salary and you do not need to pay self-employment tax.
Both LLCs and sole proprietorships offer unique advantages when you establish a business.