While all freelancers are technically business owners, not everyone considers them such. In some instances, freelancers who don’t treat their endeavors professionally are partly to blame. But often, the lack of regard stems from misconceptions about freelancers.
Fortunately, by considering the suggested steps below, freelancers can turn negative perceptions around and establish a foundation for success and growth.
8 steps to make your freelance business official
1. Choose a type of registered business entity
Many freelancers (and other solo business owners) start out as
sole proprietors. In a sole proprietorship, no separation exists between the individual and the freelance business for legal and tax purposes.
While operating as a sole proprietorship is the simplest route from an administrative and business compliance standpoint, it has its disadvantages.
Sole proprietorship drawbacks:
Unlimited personal liability for the business’s debts: In a sole proprietorship, the business owner is personally responsible for all legal and financial obligations of the business. So, if someone sues the company, the freelancer’s personal assets—home, car, checking and savings accounts, etc.—are at risk. Likewise, business expenses and loans are tied to the individual. If the business doesn’t have funds to cover them, the freelancer’s personal assets could be used to settle those debts.
Lack of business name freedom and protection: States require that the legal name of a sole proprietorship include the owner’s name. For example, “Lana Juarez Website Design Services.” To use a more creative name when marketing her services, Lana would need to complete a state or county filing for fictitious name use, also called “filing a DBA” (doing business as).
Note that while an approved DBA gives a sole proprietorship the legal OK to use a fictitious name, it does not give the business owner exclusive rights to the name. Therefore, other businesses may also be able to conduct business using the same (or a similar) name.
No tax flexibility: In a sole proprietorship, all business income and expenses flow through to the owner’s personal tax return. No other options are available. In addition to income tax, business profits are subject to self-employment taxes (Social Security and Medicare). Even if the freelancer wants to keep earnings in the business rather than withdrawing them as personal compensation (known as taking an “owner’s draw”), all taxable income is generally subject to self-employment taxes.
Lack of credibility: Some prospective clients and lending institutions may be hesitant to work with someone who operates as a sole proprietorship. They may view an individual who hasn’t established an official business entity as less trustworthy or responsible.
How can a freelancer overcome these drawbacks? I encourage them to consider establishing a registered business entity, such as an LLC (limited liability company) or corporation. A corporation has a great deal more
startup and compliance formalities, generally beyond what many one-person businesses care to deal with.
Since I’m discussing freelance professionals in this article, I’ll offer details about the LLC structure, which tends to be more well-suited to very small businesses.
Pros of an LLC:
Limited personal liability for the business’s debts: By forming an LLC, a freelancer creates a separate legal entity for their company. That protects the freelancer’s personal assets because, in many instances (aside from personal negligence, harm, fraud, or illegal actions), the freelancer will not be held responsible for the business’s debts or legal problems.
Business name freedom and protection: By registering the freelance business as an LLC, a freelancer may use a fictitious name as the company’s legal name. That allows the freelancer to brand the business more creatively without needing to file a DBA. When the state approves the LLC’s formation filing, the business name is automatically registered and may be used in the freelancer’s marketing assets, bank accounts, contracts, and other documents and communications.
Generally, states will not allow another business to use an existing LLC’s name, so the freelancer gains some important brand protection when forming an LLC. Before deciding on a business name, I encourage freelancers to conduct a business name and trademark search to confirm that another company hasn’t already claimed the name they wish to use.
Tax flexibility: While a single-member LLC is by default taxed as a sole proprietorship, an LLC that meets the IRS criteria may elect for
S Corporation tax treatment. S Corp election may reduce a freelancer’s personal tax obligations because only their wages and salaries from the business are subject to Social Security and Medicare taxes.
Enhanced credibility: The formation of an LLC may give a freelancer enhanced credibility in the eyes of potential customers, project partners, and lenders. The fact that the freelancer has taken the steps to officially register their business and create an official entity can help instill trust and confidence in those who may potentially work with or loan money to the freelancer’s company.
2. Designate a registered agent
Most states require business entities to designate a
registered agent. A registered agent is an authorized party (individual or company) approved to be a business’s official point of contact with the state and will accept important notices and documents on the business’s behalf.
The types of communications a registered agent will receive for a business include:
- Regulatory and tax notices
- Service of process for legal notices (e.g., summonses and subpoenas)
- Government correspondence
- Business compliance documents
While some states allow a business owner to be their own registered agent, that may not be an ideal scenario. States have rules regarding the specific hours and days a registered agent must be available. They also have other qualification criteria that must be met to serve as a registered agent.
3. File LLC Articles of Organization
In most states, the paperwork to form an LLC is called either Articles of Organization or Certificate of Organization. The information requested and the fees associated with the filing vary by state. Business owners may complete and submit the form on their own or ask someone else to assist them (such as an attorney or online business filing company).
If a freelancer wants to be treated as an S Corporation for tax purposes, they will also need to file
IRS Form 2553 (Election by a Small Business Corporation).
4. Obtain an EIN and set up a business bank account
Most banks will require that an LLC gets an EIN (Employer Identification Number) from the IRS before they will set up a business bank account for someone. Even if a freelancer doesn’t have employees, they must obtain an EIN to open their banking accounts. They may also need an EIN for other purposes, including applying for business licenses and permits.
Fortunately, the IRS issues EINs at no charge. Obtaining one involves completing
Form SS-4 (Application for Employer Identification Number), which can be filled out and submitted online. The freelancer requesting the EIN must provide their Social Security number or Individual Taxpayer ID number.
5. Apply for business licenses or permits
Whether a freelancer operates as an LLC or a sole proprietorship, they may have to hold certain licenses or permits to conduct business legally. The requirements a freelancer needs to fulfill can depend on their work location, their industry, the type of work they perform, and other factors. It’s critical that business owners research their responsibilities at the state, local, and federal levels.
6. Use the LLC name and don’t commingle personal and business funds
Freelancers who form an LLC must keep their personal and professional transactions and accounts separate. Invoices to clients, business contracts, and other company documents should reflect the LLC name. Also, it’s critical to make sure business funds are used for business purposes, and personal funds are used for personal purposes—no intermixing the two!
Taking these steps helps preserve the legal separation, and the personal liability protection, of the LLC structure. Failure to maintain that division could result in a court determining the freelancer has “pierced the corporate veil” and holding the freelancer personally responsible for the debts of the business.
7. Notify your clients and vendors
It’s crucial for freelancers who have changed from a sole proprietorship to an LLC to notify their customers, vendors, and contractors. Anyone who pays a freelancer for services or sends bills to the freelancer should use the freelancer’s LLC name on checks and invoices.
8. Hire employees to grow your business
Freelancers start off as a one-person operation. Some may continue their entire careers as solopreneurs, while others may decide to expand their companies and onboard the talents of other individuals. Bringing employees into the fold comes with additional responsibilities, including payroll.
To hire staff, a business owner must have an EIN, the ID number the federal government uses for payroll tax purposes. Payroll tax account registration at the state (and sometimes local) level must be completed as well.
When a business has employees, it’s responsible for various employment-related taxes and fees. Some are deducted from employees’ pay, while the employer pays others.
Examples of employment taxes and payroll deductions:
- Federal, state, and local income taxes—These are deducted from the employee’s pay. Withholdings are based on the information the employee provides on their W-4 form.
- FICA tax (Social Security and Medicare taxes)—The employee’s pay deduction is 7.65%, and the employer pays the other 7.65%.
- FUTA—Federal Unemployment Tax is paid by employers. It is not deducted from an employee’s pay.
- SUTA—State Unemployment Tax (sometimes called SUI, State Unemployment Insurance) is usually paid by employers, although employees must contribute in some states.
A word about keeping your freelance business compliant
Freelancers who form a registered business entity should research their ongoing business compliance responsibilities. The IRS, state, and local government websites provide information about the obligations, and insights from an attorney,
accountant, or tax advisor can also prove valuable.
By staying up to date with any reporting and renewal requirements, a freelancer can continue to enjoy the benefits of having a registered business entity year after year.