Josh asks: At what point do you advise freelancers to become incorporated? When does it make sense and how do you get started?
You’re ready to incorporate when your freelance commitments – perhaps once just part-time gigs -- have become legitimate income streams that you want to better manage and protect. It should reflect your level of commitment, says Kelly Phillips Erb, tax attorney and writer of the TaxGirl blog. “In deciding, ask yourself if this is your job or your hobby,” she says.
There are a number of advantages to incorporating. For one, forming a corporation or LLC lets you shield your personal savings and assets in the event that, say, a client sues you over your work. It can limit your personal liabilities. Another advantage is that you can more formally separate and organize your finances. With a business tax ID number, you can establish separate savings and checking accounts for your business. Finally, incorporating gives you credibility. It can help you develop a brand, build your reputation and legitimize your business in the eyes of prospective clients and vendors.
To get started, you’ll want to decide which type of corporation best suits your business. Personally, I am an S-Corporation, which my accountant judged was best for my single-woman production company, as it provides some payroll tax savings. Another popular route for freelancers is to become a Limited Liability Corporation (LLC). My advice would be to invest in a one-hour meeting with a certified public accountant and get his or her professional opinion regarding which type of corporation is best for you. Once you choose, you’ll have to register your business first with your state, something your CPA can help you tackle. You can also check out step-by-step directions for yourself at the Small Business Administration’s website.
And, hey, it’s perfectly possible to reach the conclusion that you don’t need or want to incorporate. Sole proprietors that aren’t incorporated, according to the SBA, own about 70% of small businesses in the U.S. “People think somehow when they incorporate, it makes things easier. But based on the kind of entity, it could be more complicated to navigate,” says Phillips Erb. “It’s not a just matter of tacking ‘Inc.’ onto your name, but finding out what’s best for you and your business.”
Kate asks: I have been saving little by little out of each paycheck the last 2 years and have saved low five figures. The money is just sitting in my bank saving account earning 0.01%, barely anything. Is there a better place to stash this money? I don't need it for emergencies. I always keep enough in checking to cover unexpected costs, travel and discretionary spending. I may want this savings for a down payment on a home one day but not certain.
Kudos to you for sticking to a savings regimen! Now for the fun part – figuring out what the heck to do with it.
To keep your money protected, growing and relatively liquid in case you do decide to buy that house someday, I’d suggest looking into some online banks that offer more attractive rates at around 1%. For example, at Ally Bank you can earn 1.04% on a 12-month CD with no minimum deposit. If you want more liquidity, the bank’s “No Penalty” 12-month CD offers a slightly lower 0.950% APY with the advantage of letting you withdraw your money six days after depositing without penalty. SmartyPig.com, an Internet savings bank that holds funds at BBVA Compass, currently offers a 1% return on all accounts. And American Express Bank is advertising a high-yield savings account with a 0.90% APY.
All those savings vehicles are beneficial if you do want to tap your savings in the near term. But what about retirement? Have you been saving aggressively for that long-term goal, too? If you’ve been participating in your company’s 401(k), great, but it never hurts to do more. Consider opening a Roth IRA with some of your savings. It’s a retirement investment vehicle that offers tax benefits and the flexibility to withdraw your contributions pretty much at any time, penalty-free, like a traditional savings account. You can invest up to $5,000 for the 2012 tax year and $5,500 starting in 2013.
While Roth contributions do not lower your taxable income today like traditional IRAs, the advantage is that you can make tax-free withdrawals starting at age 59 ½. Another benefit is that you can withdraw your earnings at anytime for any reason five years after opening the account without paying a penalty or taxes. And if you still want to buy your first home later, you’re again in luck with a Roth IRA because it lets you withdraw up to $10,000 of your total earnings tax-free and penalty-free to help purchase a house (if the account has been open for five years).
Got a question for Farnoosh? You can reach her on Twitter @Farnoosh or email her at email@example.com.