Should you incorporate, and other freelance finance topics

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Newsletter recommendation

My new favorite newsletter about freelancing is writer Lisa Beach’s Expert-ish Freelancer. Not an affiliate deal; Lisa shares really practical, well-written tips for freelancers who want to feel more confident, make more money, and save time. Having written 1,000+ articles for Training for Translators, I’m a pretty discerning consumer of newsletters for freelancers, and I really like what Lisa writes!

Should you think about incorporating your freelance business?

Thanks to a couple of readers who suggested this as a newsletter topic! Most importantly, I’m not an accountant, tax planner, or attorney. Verify these tips with a pro!

As with many things related to freelancing, we tend to overcomplicate. If you’re just getting started as a freelancer, or if you haven’t thought much about freelance finances, you can put yourself ahead of at least 70% of other freelancers (trust me on this one…) if you:

• Completely separate your business and personal finances, even if that’s just a separate checking and savings account in your own name, that you use solely for business purposes; and
• Earmark a percentage of every client payment for taxes and other business expenses. “A percentage” is going to vary depending on your tax bracket, whether you pay for your own health insurance, etc., and “earmark” is going to depend on your needs. When I made less money, I would just chop 40% off every client payment and move it to my business savings account. Now, I keep a lump sum (in my case, $15,000, which is enough to keep my business afloat for three to six months) in my business savings account and don’t touch it; and
• Know how much you need to charge in order to reach your target income. Again, basic, but lots of freelancers are working for whatever clients seem willing to pay, and hoping that it adds up to enough money to pay the bills! Two helpful resources: my Deciding What to Charge worksheet, or JT Hine’s booklet I Am Worth It.

If you haven’t done those things yet, don’t even think about incorporating. Set up the framework first.

My experience with an S-Corp

As far as incorporating, I can only speak from my own experience; I’m not familiar with corporate structures outside the US, or with corporate structures I don’t use, but I think that these basic principles can be helpful as you look at whether incorporating could be helpful for you.

I’ve had an S-Corp for 15+ years and it has a lot of advantages. Most importantly, an S-Corp allows you to legally avoid paying self-employment tax on part of what you make, through a (somewhat artificial, but legal under the IRS rules) distinction between your “wages” (which are subject to self-employment tax) and the “corporation’s profit,” (not subject to self-employment tax). You sill pay regular income tax on the “corporate profit,” but you avoid the 15.3% self-employment tax on top of what you would pay if you worked for an employer.

Of course, what constitutes a reasonable wage (the IRS’s definition of the amount on which you must pay self-employment tax) is very subjective. My accountant tells me to take my gross income, subtract my business expenses, and divide the rest equally between wages and profit. I’ve heard other accountants tell people to use the US Bureau of Labor Statistics’ median pay for translators and interpreters ($57K in 2023) as your base wage amount, and take the rest of what you earn as profit. There’s really no hard and fast rule.

Being incorporated saves money in taxes (back of the envelope, being incorporated saved me about $8,000 in taxes last year), but it also creates an administrative burden which is likely to require an accountant. In my case, business accounting adds up to more than $2,000 per year, because my accountant charges a monthly fee to prepare my payroll taxes (required for S-Corporations), and requires me to subscribe to Gusto, an automated payroll processor that pulls the money out of my business account, then directs it to the appropriate tax entities and pays my salary into my personal account, and an S-Corp has to file a separate corporate tax return, which my accountant prepares.

Thus, you want to consider the income level at which it would be advantageous to incorporate. Again, no hard and fast rule here: maybe $60,000 a year?? If I had to guess, something between 45 and 65K is the point at which, even if you hire an accountant, you’re probably better off incorporating.

In the US, corporations are formed at the State level. Check your State’s Secretary of State office for the fees and requirements. Here in Colorado, it’s quite easy and cheap to form a corporation, but you want to make sure that the corporation is going to confer the benefits that you’re looking for. Specifically, having a corporation protects you from some types of liability, but not others. For example, I rent an office outside my house. If I were to sign the lease in my corporation’s name, and then the corporation went bankrupt, my understanding is that the landlord could not sue me personally for the money. But a corporation does not protect you from things like errors in your work: only professional liability insurance can do that; clients can sue you personally for work-related errors.

Pro tip: If you’re going to use an accountant (for most freelancers, this is the first task I would consider outsourcing if you can afford it), use an IRS Enrolled Agent (EA). EAs will often put those initials after their name; using an EA means that the accountant can represent you in most dealings with the IRS, and you should never have to interact personally with the IRS, even if you get audited. This is a huge advantage: years ago, I received a demand letter from the IRS, saying that I owed $15,000 (!!!) in unpaid taxes on income in my PayPal account. I knew that this wasn’t true, but I had no idea what the issue was. I sent the demand letter to my accountant and signed a release form for her to talk to the IRS, and she ironed it out with one phone call (confusion between my personal Social Security number and my business EIN!).

I hope these tips are helpful!