Congratulations on your decision to become a business owner and do some freelance work.
In this role, you will wear many hats. You will both be employee and boss and you’ll decide on every aspect of your business.
As a new freelancer you’re going to have to learn what comes with having your own business.
And one of first of many decisions for freelance work is to choose the name of your company and its business structure.
It may not be the most exciting part of freelance work, but it’s definitely one of the most important.
Why?
It impacts your day-to-day operations, how your income is taxed, and if your personal assets are at risk.
Read on for tips on how to choose the most beneficial structure for your freelance business so you can do some freelance work.
Freelance Work – Your Freelance Business
As a new freelancer you’re going to have to learn what comes with having your own business. Registering your business, structuring your freelance business, separate entities and running your freelance work as a business will help you be successful and do this long term.
1. Registering Your Freelance Business
The steps and costs of registering a freelance business will vary depending on the country, state, province, or sometimes even the city where you live.
The rules on whether or not you need to register your business if you’re a sole proprietorship also varies.
However, once you start making real money, you’d want to register your freelance business for the following reasons:
- A registered business has more tax advantages than an individual
- There are legal protections that a business can provide to cover you from lawsuits
- It contributes to brand awareness
- You will need it for proof to be able to open a business bank account
What’s the Next Step?
You will also need permits and licenses to make sure you’re operating legally. Generally, only businesses who sell physical items need a seller’s permit. It’s the permit that allows a business to collect sales tax.
But some states (US) require it for certain service-oriented business too. So, you have to do your due diligence there.
For freelancers in the US, the IRS and SBA.gov are great resources with regards to registrations and licences you’ll need to operate as a business.
If you live in Canada, check out Canada.ca and Bizpal. These websites can help you find the permits you need based on your location, business activities, and industry.
2. Types of Business Structures
1. Sole Proprietorship
As a sole proprietor, you are the business as far as laws and taxes are concerned. Your profits are taxed as personal income and you’re personally liable for debts and losses of the business.
Registering as a sole proprietorship can be a good starting point for your freelance work. It allows you to get your brand and business idea out before forming a more formal structure.
2. Partnership
A partnership is a sole proprietorship with at least two owners sharing in its profits or losses and making decisions in all aspects of the business.
3. Limited Liability Company
If you register your freelance business as an LLC, your profits will be taxed as a personal income. But you are protected from being personally liable from creditors or lawsuits that may be filed against the business.
According to NSBA’s 2017 Economic Report, 35 percent of businesses in the US are structured as an LLC.
Mostly because it has fewer filing requirements compared to a corporation, but still offers that personal assets protection.
The initial process of forming an LLC includes:
- Registering in the state where you live
- Paying the filing fees
- Providing an operating agreement
And to maintain your registration in good standing you should,
- Pay the annual fees
- File annual information reports when due
- Pay your taxes on time
- Make sure you achieve that separation of personal and business finances
Presently, an LLC is an option only in these countries: US, U.K., Switzerland, Chile, Colombia, Italy, Japan, and India.
4. S Corp
To put it simply, an S Corp is a corporation that elected to be taxed as a sole proprietorship. For tax purposes, an S Corp passes credits, income, losses, and deductions to its shareholders.
This allows small businesses to enjoy the benefits of the limited liability that a corporation provides while bypassing double taxation.
The keywords here are corporation and election.
To incorporate, your freelance business has to be eligible. If it is, you will file Articles of Incorporation with the state. And pay all the necessary fees. And then, file another set of documents to elect the “S” corporation status.
If you are at the point of your freelance business where forming an S Corp is beneficial, part of your expense will be for a lawyer and an accountant to help you with the initial process.
And the yearly requirements such as:
- Annual shareholder meetings
- Annual reports
- Paying annual fees
- Keeping detailed records of all financial and legal dealing of the company
5. Corporation
When you incorporate your freelance business, you are creating a separate legal entity that has all the legal rights of an individual, except for the right to vote and other limitations.
A corporation can enter into contracts, borrow money, hire employees, pay taxes, etc.
If you are just starting out as a freelancer, the process of forming a corporation and the requirements necessary may not be the right structure for your small, informally run business…yet.
Not to say you can’t incorporate your business in the future. Most of the big names in the blogging, photography, and online education industry started out as freelancers. And they are operating as either S Corps or corporations now.
If you are just starting with your entrepreneurship journey, choose the business structure that gives you the right balance of protection and benefits. You can begin by asking these questions:
- How easy or complex is the registration process? Do you have the time, money, and resources to spend on it?
- Are you making enough money from your freelance business to benefit from tax advantages of the more formal business structures?
- Are the day-to-day activities of your freelance business high-risk for debt and general liability?
3. Setting-up Your Freelance Business as a Separate Entity
If you are a freelancer who haven’t registered for any of the formal business structure, you are a sole proprietor.
And according to the law, that doesn’t create a separation between you and the business. You still need to make sure you are treating your freelance business as a separate entity.
What is a Separate Entity?
In accounting, it means separating your personal transactions and finances from your business activities.
Why Do You Need to Separate Personal Transactions From Your Business Activities?
Once you claim a business you start taking advantage of the tax benefits, such as business expenses on your tax return. You must be able to prove that you are operating as a business, and not as a hobby claiming to be a business, in order to lower your taxes.
If your freelance business is downgraded into a hobby, most of the deductions you claimed will be rolled back.
You will be asked to pay back taxes and maybe even penalties and interest – not just for that year but for all previous years that you claimed for.
4. Treating Your Freelance Work as a Business
You’re excited for all that freelance work you’re going to land. Article projects, podcast translation projects and newsletter campaigns here I come! Before you get out there and start that freelance work, understand you need to treat this as a business, and not as a hobby.
1. Achieve Separation of Business and Personal Finances
Go ahead and open a business bank account or a separate account for your invoices. It is difficult to separate your personal and business finances if they’re all in the same account.
2. Track Your Hours
Record all the time you spent working, meeting with clients, editing, etc. by keeping records. If you’re audited, you can use it as proof that you’ve been doing freelance work – even if you are not turning a profit yet.
3. Track Business Income and Expenses
You can use good old-fashioned pen and paper, Excel, or any app you fancy. Just keep records of invoices and when you receive the payments. Keep receipts for all business expenses. Examples are website hosting services, job board fees, ad promotions, and office supplies.
4. Hire an Accountant
When it comes to taxes, it is better to get it done right the first time. A simple mistake, even an honest one, can still cost you penalties and interests. So, consider hiring an account for your taxes.
Final Thoughts
Was that a lot of information, all at once? I hope not.
At the very least, I hope this post was able to give you some insights in the legal and financial aspect of your freelance business so you can do that freelance work the right way.
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