If you are like most freelancers, you likely started freelancing as a side business while continuing to work at a different full-time job. As long as you freelanced only on a part-time business, it likely made sense to just report the income you earned from it as miscellaneous income on your tax returns. At some point, however, you may need to establish a formal legal structure for your freelance business, especially if you have moved to full-time freelancing work. When you are a freelancer, you are a small business owner. Understanding the best legal structure for your small business is important. Three are three main types of legal structures that freelancers often choose for their businesses.

Sole proprietorships

Sole proprietorships are very simple structures because they do not require you to do anything. If you are already operating your freelancing business, you are doing so as a sole proprietorship. Under the rules of the Internal Revenue Service, sole proprietorships are considered to be disregarded entities. This means that you do not have to file separate business returns, and you may simply report the income you earn from running your business on your personal tax returns. There are drawbacks of operating your freelance business as a sole proprietorship, however. If your business is sued, there is no limit on your personal liability. This means that creditors can come after your personal assets directly to satisfy any judgments that they might win against your company because of the content that you sell. Because of this, many freelancers eventually decide to form limited liability companies or S-corporations.

Limited-liability companies

Limited liability companies must be formally registered with the states in which they are formed. You are able to form a single-member LLC by filing the required documents with the state. The primary benefit of forming an LLC is that the structure limits your personal liability. This means that if a company or individual sues your business, your personal assets will be protected if the lawsuit is successful. LLCs are pass-through entities meaning that you do not have to file a separate business tax return. Instead, your earnings are considered to pass through to you, allowing you to report them on your personal tax return. You will also be able to deduct your pre-tax expenses that are related to your business such as miles that you have to travel and home office expenses if you work from home in an office that qualifies under the IRS's rules. You will have to contend with self-employment taxes, so it is important for you to set aside an appropriate percentage of what you earn to pay towards your tax bill at the end of the year.

S-corporations

Similar to LLCs, S-corporations protect your personal assets from the reach of creditors who might file lawsuits against the businesses. These entities have stricter rules than do LLCs or sole proprietorships, however. You are required to pay yourself on a salary basis, and you may earn dividends on the profits that your company makes in addition to your salary. S-corporations must file business tax returns instead of reporting their business taxes on their personal returns. If you have a partner in your S-corporation, you must pay your partner fairly. The IRS may otherwise penalize you for unfairly compensating a partner.

Freelancing is the sole career that many people have. When your freelancing business reaches a certain point, leading you to start doing it on a full-time basis, it is time for you to consider the type of legal entity structure that will work best for your business. By setting up the correct legal structure for you, you may have better protections and secure more tax advantages than you might by simply continuing to operate as a sole proprietor.