Loss Strategies. If you have been filing a Schedule C and have already used up your 2 years of losses, you should consider whether forming a separate business will protect your losses. In protecting your losses, you must take into account the added cost of a potential IRS audit (even if you succeed in defending yourself), plus the added cost of incorporating in your home state.
In general, if your business activity is expected to be profitable over the long-term, I recommend forming a regular C-corporation. Current losses will reduce future profits. The IRS has explicitly said that the 3-out-of-5 year rule does not apply to C-corporations.
In general, if your business activity is expected to generate losses for the foreseeable future, I recommend forming a partnership or an S-Corporation. Current losses will reduce current income on your 1040. Future profits, if any, will not be reduced by previous losses. In order to form a partnership, you will need at least two shareholders. This could be a spouse, significant other, or really any other person. And it doesn't need to be 50-50. Your partner could own as little as 1% of the partnership.
Of course, you can continue to report your losses on a Schedule C. There is no additional costs to bear in incorporating your business. However, you must prepare yourself for the potential cost of an IRS audit. You can prepare yourself by keeping a business diary in a daily planner, keeping excellent records of your income and expenses, and conducting your freelance work in a very business-like manner. This means promoting your business, competing for contracts and other freelance gigs, maintaining an office, having regular hours of operation, and separating business expenses from personal expenses.
