Sole Proprietorship (Default)
A sole proprietorship is the default state of freelancing. It requires no formal paperwork. All business income and expenses are reported on Schedule C of your personal tax return.
The major downside: All net profits are subject to the full 15.3% self-employment tax, plus ordinary federal and state income tax. Furthermore, you have zero personal liability protection—if a client sues you, your personal assets (house, car) are at risk.
Single-Member LLC
A single-member Limited Liability Company (LLC) establishes a legal wall between your personal assets and business liabilities. By default, the IRS treats a single-member LLC as a 'disregarded entity'. This means it is taxed exactly like a sole proprietorship.
While it provides vital legal protection, forming a standard LLC provides absolutely no direct tax savings.
S-Corporation Election
Once your net freelance earnings consistently exceed roughly $80,000 to $100,000, filing Form 2553 to elect S-Corp status can provide substantial, legal tax savings.
The S-Corp Tax Saving Mechanism:
1. You divide your business net income into two buckets: **Reasonable Salary** (W-2) and **Owner Distributions** (Dividends).
2. You pay the heavy 15.3% self-employment/payroll taxes *only* on the Salary portion.
3. The Distributions portion is completely exempt from self-employment taxes. It is only subject to regular income tax.
S-Corp Drawbacks
S-Corps come with significant overhead. You must run official payroll (using software like Gusto), file complex corporate tax returns (Form 1120-S), adhere to strict bookkeeping requirements, and pay unemployment taxes.