Blogger Kara Perez breaks down the next steps for any Grownup considering getting a little more serious about their freelance endeavors.
Freelancing and contract work is the name of the game right now. One-third of the American workforce is made up of freelancers and there’s no sign of that growth slowing down. With such demand for freelance workers, freelancers need to protect themselves as they run their businesses. There’s no guarantee for freelancers in anything they do, from getting work to getting paid.
If you are seriously pursuing a freelance career, or are making good money as a freelancer and want to protect yourself from liability, you might want to form a Limited Liability Corporation (or LLC for short). LLCs offer more legal protections than sole proprietorship does. It’s a way to formalize your business.
Most freelancers start off working as sole proprietors. You automatically count as a sole proprietor the minute you start operating as a business. There’s no formal registration required, and your business taxes are filed with your personal taxes. For many people, maintaining a sole proprietorship is enough for their business.
The Pros of a Sole Proprietorship
- They’re easy and inexpensive to form. There’s no distinction between individual and business, so almost nothing changes in your financial and tax life.
- There’s only one owner: you. Nonprofits must have a board of directors, and LLCs can be multiple people. Sole proprietors call all the shots.
- Your taxes remain simple. You file taxes as an individual, including money you made as a business.
The Cons of a Sole Proprietorship
- You’re liable for everything. Since there’s no legal separation between you and your business, you can be held personally liable for the debts, losses, and obligations of the business. Someone suing your company can come after your personal finances and assets.
- Finding investors is challenging. You don’t have a formal company, so you can’t sell shares in anything. You also may face challenges securing a loan from a bank. Banks see a sole proprietorship as a riskier investment than an LLC, since business and personal finances are one and the same.
Should you form an LLC? If things are going just dandy as a sole proprietor, why would you need to upgrade to an LLC?
Forming an LLC is slightly different from state to state. In Texas, where my LLC is held, you must:
- Register a unique business name
- State whether the LLC will be member-managed or manager-managed
- Appoint a registered agent and list their address and name
- List the names and addresses of the managing person
- List the name and address of the LLC organizer
- Pay a registration fee of $308.
If your LLC has more than one member, you must obtain an employment identification number (EIN) from the IRS. If you sell goods, you must register with the Texas Comptroller Office and pay sales tax.
All of this can be done online. It took me about an hour to form my LLC. Other states require an operating agreement, which states how the LLC will be run, who is responsible for what, and other legal and operational details.
Forming an LLC is a game changer. You now have a distinction between your business and your personal finances. Your LLC affords you the legal advantage of protecting your personal assets from your business assets and debts.
By setting up an LLC, you also avoid paying both personal and business taxes on your freelance income. As a legal pass-through entity, your LLC’s income and expenses get reported on your 1040 tax form as the business operator.
Consider forming an LLC if:
- You have large-scale business growth plans. If you plan to reach out to investors, an LLC is the minimum they will look for. Investors are not giving you money—they’re investing in a company and will expect to see profitable returns.
- You want a legal distinction between personal and business finances.
- You plan to hire multiple employees, or sell material products down the line.
- You have the money for a lawyer and to pay the filing fees. (Filing fees vary from state to state.) A lawyer can help explain the process and file the papers for you for a fee.
Forming an LLC is not necessary for everyone, but it does afford a level of legal protection and business credibility. It’s more formal than a sole proprietorship, and people recognize that. You should research the laws and regulations around LLCs in your state, as well as craft a business plan, before registering for one. It may be just the thing to take you to the next level of your business—or you may find it unnecessary for your work. Only you can make that call.
Kara Perez is a freelance personal finance writer living in Austin, Texas. She is passionate about helping people become financially literate and telling people’s money stories.
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While Society of Grownups hopes the information is useful, it’s only intended to provide general education. It’s not legal, tax, or investment advice, and may not apply or be useful to your specific financial situation. If you need recommendations geared to your personal financial situation, schedule time with a financial planner professional.
This post is not legal advice and does not create a confidential attorney-client relationship. It is being offered for informational purposes only. For personalized advice, consult a business law attorney in your area.