When individuals go into business for themselves, they are considered independent contractors who offer services for a fee.
Freelancers don’t have to stay under this employment identification for the rest of their lives, but determining when to incorporate as a private limited company is often a struggle. In this article, we’ll discuss when, how, and why to incorporate.
What are the benefits of incorporating?
There are several benefits of incorporating for freelancers, including:
- Limited Liability: After incorporating, your liability is only limited to the amount of money you contribute to your business. All of your personal assets are protected.
- Tax Benefits: Self-employed professionals have to pay a high amount of taxes, but you can save thousands of dollars once you become a registered business.
- Better Credibility: Customer perception of a private company is higher than a solo entity. As a business, you’ll find more client opportunities and higher-paying projects.
If you’re interested in hiring employees once you’re incorporated, but you’re not sure how to draft professional-looking paychecks, read more here to learn how to create paystubs.
The freelancer can divide their earnings anyway they want
Freelancers who incorporate as a private limited company have access to many tax breaks. Here are a few ways you can save money by hiring your family or friends as employees.
Income splitting and child tax
When you become a business owner, you can start splitting your business income by paying some of it to family members as salary or wages or by transferring income through dividends. Income splitting via a personal allowance can also help your family earn a better retirement because you’re both contributing to your country’s retirement savings plans.
You can also use your children to reduce tax, but this money is classified as disposable for capital gains purposes. It’s important to remember that these rules only apply to children under 18 years of age. If they’re over 18, you can still receive tax benefits while they’re studying.
Dividends and employment tax
Income can be further divided by paying dividends to your spouse or children, as long as they’re classified as shareholders. You can use this option instead of hiring them as employees. To take full advantage of this, your corporation needs to include non-voting share classes.
Of course, you can divide your income amongst employees and other independent contractors you hire. If you’re a business entity with few employees, you receive even more benefits.
UK taxes are lower than US taxes for freelancers
It’s true that corporation tax rates are much higher in the USA than they are in the UK. In the UK, the primary corporation tax rate is 19%, and in the US, it remains at 21%.
President Biden has stressed that he wants to raise corporate income tax to 28 percent, but it’s more likely he’ll keep that number at 25%. On average, UK business owners save £1,500-£4,700.
Freelancers can separate their business and personal identity
When you legally separate your identity, it is easier for you to draw a line between your professional career and personal life. Getting your own business bank account for your private limited company can help you keep track of your business income, keep accurate records of business expenses, and build business credit. This will save you time during tax season.
Being an entrepreneur can blur the lines between your actual identity as a person. It’s all too common for self-employed freelancers to overlap both selves, which is detrimental to their personal life. Keeping both identities separate can drastically improve your mental health.
The difference between an LLC and a Public Limited Company
An LLC is a privately owned business, and a public limited company (PLC) is one that’s publicly traded on the stock market. To become a PLC, you also need to be an LLC. Both company types provide liability protection against lawsuits and debts.
In both cases, these companies receive “pass-through” taxation, meaning the companies’ profits and losses pass through to the owners, who then report their earnings on their income tax.
Forming an LLC takes less time because it only requires filing for appropriate licensing and insurance. PLCs require shareholders, publicly traded shares, two directors, a qualified company secretary, and registration with Companies House. This process is much longer.