Running a freelance business typically means you spend the majority of your time on your actual freelance work — whether that’s graphic design, writing, photography, web development, or something else.
The “running a business” part of that equation can be all too easy to neglect when you’re navigating the daily hurdles of deadlines, client demands, and finding your next project. This is especially true if your freelance is a side hustle and you have a regular full-time job.
But even if you’re both the boss, and the only employee of your company, it’s a good idea to spend at least a little time thinking about your business setup and making sure it’s optimized.
So what’s the deal with all the different business classifications? And why would you need one just to freelance?
In this post we’re going to break down that “what” and “why” behind the three most common business setups for freelancers.
If you don’t register a business as a freelancer, you’re considered a sole proprietor. This is just a fancy way of saying you do your freelance solo. When it comes to taxes, you receive 1099s from your clients, and itemize any freelance business-related deductions using what’s called a “Schedule C” in IRS-lingo.
While going with the default option is convenient for obvious reasons, you sacrifice liability protection with this setup because you have no legal separation between your personal and business assets. Essentially you are your business, and your business is you.
If you still have a day job and freelancing is just a part-time or side gig, your liability risk may not be very big. However, if you’re a full-time freelancer, or starting to take on bigger jobs, you could be assuming quite a bit of risk as a sole proprietor.
If you get sued by a client (or creditors come after you for a business bill) and you have a car, a home, a retirement account, or personal savings, any of those things could be on the line.
Before you scoff at the idea of being sued by a client, consider that at some point in your freelance career you’re bound to make a mistake. It’s just an unfortunate fact of being human.
Great writers occasionally miss a fact that should have been checked. Talented designers sometimes make errors on print files. Amazing web developers will eventually write a piece of code that malfunctions.
If your mistake happens to cost your client a lot of money, they’re probably going to look to you to either a) pay the cost in part or full, or b) provide make-good services (i.e., free work) to make up for it. Even if you think you’re not at fault, you may need to hire a lawyer to help you prove it, and you can expect that to set you back at least a couple thousand dollars, if not more.
Sole Proprietor Pros:
Sole Proprietor Cons:
Everything you need to know about this business set up is in the name. Registering your freelance business as an LLC in your state limits your business liability, and protects your personal assets by separating them from the business.
The bottom line is, if freelance is your full-time job and you want to run your business professionally, and give yourself some liability protection, setting up an LLC is a no brainer.
If you’re one of the few lucky freelancers making well into six figures every year, then you might consider a more complex set up, like the single member S Corp below that offers liability protection along with additional possible benefits for big income earners.
Single-Member LLC Pros:
Single-Member LLC Cons:
If you have years where you’re swimming in the freelance dough à la Scrooge McDuck, you may be able to save some money at tax time by registering as an S Corp instead of as an LLC.
We say “may,” because there are many factors that go into this, including your net income, typical wages for your industry, and your business location, since S Corp fee and tax structures vary depending on state and local laws.
The short(ish) story with the S Corp as a solo freelancer is that you are the owner, an employee, and a shareholder of the company. The S-Corp pays its employee (you) a salary, and the remainder of its net income is considered a dividend, which can be distributed to shareholders of the S-Corp (in this case, also you), and you may be able to use these distributions to lower your tax rate.
The long story is, the S Corp is a pretty complex set up for the average freelancer, especially if you’re just starting out or not working full-time. If you’ve been in business for awhile, and want to pursue it, you should hire a CPA to help you evaluate whether it’s a good choice, and help you with the set up.
We wouldn’t recommend this one as a DIY business project, and you need to make sure you look closely at all the additional costs of operating an S Corp, not just the potential tax savings.
S Corp Pros:
S Corp Cons:
However you decide to set up your freelance business, you should take the time to understand your options, and make an intentional decision. Just because you’re a company of one doesn’t mean you shouldn’t run your business like a boss. Since you’re already busy adulting, why not check out our post on your retirement options as a freelancer?
Disclaimer: As with all advice on the internet, we recommend that you don’t make any major financial decisions for your business based on reading a single article. Do your research, and talk to a qualified CPA who understands your industry, as well as the local, state, and federal tax laws that apply to your specific business.
Posted on
April 30, 2019
