Discover whether freelancers should choose a sole proprietorship or an LLC for their business. Learn the benefits and drawbacks of each option to make an informed decision.
Find out about tax advantages, personal liability, financing obstacles, and how to safeguard your assets. Get professional advice for setting up the right business structure for your freelance career.
Which is better for freelancers: a sole proprietorship or an LLC?
When you begin your freelance career, you usually spend all your time searching for jobs and focusing on your tasks. However, as your business grows, you'll face important decisions. One of them is whether to operate as a sole proprietor or put in the effort to create a limited liability company (LLC).
Both options have their advantages, such as being able to deduct expenses for your home office and other business-related costs. But each choice also has some drawbacks. To figure out which business structure suits you best, consult the following guide for all the necessary information.
Does Freelancing Require Business Entity Registration?
If you haven't registered your firm formally, but you're doing paid freelancing work, the IRS will consider your business a sole proprietorship when you file taxes. However, this might not be the best option for you.
Your business structure can affect things like personal risk and tax payments. Therefore, it's essential to understand your choices and make a careful decision.
A Sole Proprietorship: What Is It?
As a single business owner, you have a sole proprietorship, which is considered a "pass-through" entity for tax purposes.
To simplify the process, you just report your freelancing income on your personal tax return using a Schedule C form. Include this information in your 1040 or 1040 EZ.
Although filing taxes as a sole owner is straightforward, there are some extra steps you need to take. It's important to carefully track your company's income and expenses or hire a bookkeeper to do it for you. This information is necessary to complete your Schedule C, which is a standard procedure for every profitable business.
Moreover, remember to pay self-employment tax and quarterly estimated taxes as a sole proprietor. Neglecting these payments can lead to trouble with the IRS.
Top Benefits for Freelancers of Sole Proprietorship
You'll love the simplicity and ease of sole proprietorships, which is why they're so popular. No need to worry about extra paperwork or complicated tax reporting. In some cases, you won't even have to formally register your firm. If you want to market your company with a specific name, you can easily submit a "doing business as" (DBA) form with the state.
Drawbacks of a Sole Proprietorship to Consider
As a freelancer, you often opt for sole proprietorships because they are the easiest business structure to set up and manage. However, you should consider a few potential drawbacks as well.
Financing Obstacles
If you're a solo entrepreneur, getting finance for your company can be tough. Lenders may hesitate to approve your loan requests because they consider sole proprietorships less reliable than other business types. Moreover, this structure makes it difficult to partner with investors and leaves you with limited options for raising cash.
Insufficient personal defence
In a sole proprietorship, there's no legal or monetary separation between you and your firm. So, if you manage to secure a loan for your company, you'll have to personally guarantee it. This means that if your company faces financial difficulties, you'll be personally responsible for repaying the loan.
Be cautious because if your business gets sued for publishing something considered libelous, causing a security breach, or any other action that leads to your client's losses, you might have to give up your savings, home, and other possessions to settle the business debts.
What Is an LLC?
If you want more protection as a freelancer, you can opt for a single-member LLC registration. With this setup, you can run your business as a sole proprietor while enjoying the legal benefits of a corporation.
Whether your company is big or small, a traditional "C corporation" requires more paperwork and ongoing responsibilities compared to an LLC. So, if you're an independent contractor, choosing an LLC can be a practical and simpler option.
Principal Advantages of LLCs for Freelancers
To keep your business and personal assets separate, register your company as an LLC. This way, you won't risk your personal belongings if you face a lawsuit related to your business activities.
Additionally, forming an LLC allows you to bring in partners, offering more opportunities to raise capital and expand your business. Even if you start as a single-member LLC, you can always change this arrangement later if needed.
LLCs also provide various tax advantages.
Since this is a "pass-through" corporation, you don't need to submit a separate corporate tax return to report the income. If you have a single-member LLC, it's treated as a sole proprietorship for tax purposes, while multi-member LLCs are considered partnerships.
LLC Drawbacks to Think About
While forming an LLC offers significant security for business owners, there are some potential drawbacks you should be aware of. Here are a few common concerns:
1. Initial Filing Requirements:To register your LLC, you need to submit articles of incorporation to your state. This process requires both time and money.
2. Costs Involved:You'll have to write the articles of incorporation, submit them to the appropriate agency, and pay a filing fee before commencing your business. The expenses can range from $50 to $500, depending on your state, and may also include fees if you seek assistance from a professional to navigate the process.
Constant Upkeep
Moreover, you need to adhere to certain requirements to keep your corporation status intact. Each year, you must submit an annual filing and pay a fee to several states. The cost for this can range from $15 to over $250, depending on the state where your LLC is registered. It is essential to be mindful of the filing deadlines and how often they occur to avoid paying hefty fees or risking the loss of your LLC status.
Make a Pros-Cons analysis. then decide which is best for your company.
When deciding on the perfect structure for your freelance business, there are several things to consider.
Firstly, ask yourself if you are committed to pursuing a freelance career. If you are uncertain about turning your hobby into a business, setting up an LLC might not be necessary or worth the cost.
However, if you have plans to expand your business and want to be prepared for potential liabilities that come with success, establishing an LLC could be a wise decision. It offers a way to safeguard your personal assets from any potential risks.
It's normal to feel unsure about the best course of action. Freelancers often need time to understand their potential earnings and financial responsibilities. Additionally, freelance businesses can go through ups and downs, so what works for you now may not be the best choice in a few years. Take your time to assess your situation and make the right decision for your freelance venture.
You can always alter your mind, which is wonderful news.
You can easily handle the paperwork to form or dissolve your LLC, depending on how your freelance business performs. Seek professional advice for important decisions related to taxes, legal matters, and finances. A trained business consultant can help you analyze your current and projected income and assess your company's risks.
Share this information with a legal or tax expert who will guide you on the best actions and how to complete the necessary documentation.
While it may seem like a daunting task, you'll probably find that it's not as scary as you initially thought. Putting in the effort to set things up correctly is essential as it will give you peace of mind and set you up for business success.
