Q. Some writers have formed limited liability companies (LLCs). What’s the advantage?
A. An LLC is an entity with the advantage of limited member liability and flexible tax structure. Although a single-member LLC by default is treated by the IRS as a sole proprietorship, a single-member LLC also may choose to be treated for tax purposes as a corporation (either a “C” or an “S”).
Major Features of an LLC:
- Income taxes. For C corporation LLCs, tax rates start lower than individual rates, but when you withdraw corporate profits, there is a double taxation: it is taxed again at your personal rate. (Double taxation can be avoided, however, by simply paying out all corporate profits as salary.) By contrast, the sole proprietorship LLC or S corporation LLC “passes through” all income (and losses) to the member, thus eliminating double taxation — but you cannot retain earnings in your LLC account for future use.
- Employment taxes. As a sole proprietorship or partnership LLC, you must pay the self-employment tax of 15.3% on salary or earnings. If you elect corporate status and pay yourself salary, the corporate FICA and Medicare tax contribution, plus the employee’s FICA and Medicare tax contribution, also equal 15.3%.
- Fringe benefits. In general, in sole proprietorship, partnership, and S corporation LLCs there is lesser deductibility of fringe benefits and smaller retirement plan contribution limits and plan flexibility than in C corporation LLCs. For example, a C corporation LLC can have a tax-free medical reimbursement plan for you and your family members – a major advantage.
- Fees and Paperwork. There are initial and annual fees to the state where you set up your LLC, and your state may impose a minimum tax on your LLC, no matter how much (or how little) income you have. If you choose C or S corporate status (or are a partnership LLC), a separate tax return will be necessary, and you can count on a larger bill from your accountant.
- Limited Liability. Being an LLC will protect you personally from certain creditor’s claims against the LLC. Freelance writers, however, rarely accumulate much business debt – and most lenders will require that you personally guarantee the payment of an LLC loan in the event of a default. More importantly, even if you assign your copyrights to a limited liability company, you cannot avoid copyright infringement, defamation, or invasion of privacy lawsuits – as the author, you always can be sued individually for these claims. Likewise, publishers routinely require authors to personally pay the publisher in the event of a defamation or copyright infringement claim resulting from the author’s writing.
In summary, there are some tax and fringe benefits to be gained by choosing to form an LLC and electing corporate status, especially if you generate high income and can afford expensive benefits and high pension contributions. Likewise, if you self-publish and accumulate large debts in the name of your writing business, the limited liability of the corporate entity may be useful.
© 2009 Daniel Steven