*Note, I am not a lawyer and this should not be considered proper legal advice. I am simply sharing some best practices that I wish I would have learned when I started freelancing, supported by some helpful resources. Before taking any action I would advise using a service like Law Guru to get your legal questions answered for free, or search Justia to search for a local attorney.
If you’re anything like me, you feel somewhat burdened at the thought of business plans, corporation formation, and tax season.
As a freelancer, you got into the game wanting to follow your passions, work on your own schedule, and improve your earning potential.
Not worry about if you filled out your schedule C correctly or if you paid your local state art tax or not.
However, knowing even the basics about the different type of incorporations and structuring your business (yes, freelancing is a business) correctly from the start, will save you a tremendous amount of headache down the road.
It will also save you money, which I know we can all get behind.
This article aims to answer two key questions:
- Do you need an LLC as a freelancer?
- What is the best way to legally start a freelance business?
So without further ado, let’s dive in to the two most easy to understand and common business entity types: sole proprietorships and LLCs.
What is a sole proprietorship?
The IRS defines a sole proprietorship as:
“Someone who owns an unincorporated business by himself or herself.”
If you’re already freelancing and having been generating an income with your skills, but haven’t yet incorporated into an LLC, S Corp, etc, then by default the government considers you a sole proprietorship.
What’s an LLC?
The IRS defines an LLC (limited liability company) as:
“A business structure allowed by state statute. Each state may use different regulations, you should check with your state if you are interested in starting a Limited Liability Company.”
Put more simply, it’s a simple business structure that allows you as the person, to be a separate entity from your business in the eyes of the law and the government (think taxes, more on that later).
The intention with this basic structure is to protect you from being liable of any debt or legal trouble that your business incurs.
LLC Vs sole proprietorship
Two main advantages:
- LLC protects you as a person from your business liability
- LLC has more tax breaks and more flexible tax structure as you grow
How to quickly and easily Set Up an LLC as a freelancer
There are many different products and services that help you form an LLC, including searching for your local area’s secretary of state website and following their instructions.
However, through my research I’ve found that IncFile is the most intuitive and straightforward free platform that simply guides you through the entire process from start to finish.
Just click here to get started, answer the questions to the best of your ability, and you’re all set.
Other important business considerations for a successful freelancing career
1. Create separate business and personal banking accounts.
The first thing you should do when you start earning income as a freelancer is to get separate banking accounts for your personal income and your business income.
This is simple to do and in most cases can be done directly through your existing banking provider.
You’ll want to set up a business savings and a business checking at minimum.
If you want to explore other options for your business banking, I have had excellent experience with local credit unions offering better and more personalized customer service, lower fees, better business saving account yearly returns, and more favorable loan conditions.
Alternatively, here’s an excellent breakdown of some high yield business savings accounts.
2. Utilize a bookkeeping system to track income, profit, and expenses
When tax season rolls around, you don’t want to be left scrambling to work backwards with how much money you’ve made, spent, and earned.
That’s why getting ahead of the curve and setting yourself up with a good and easy to use bookkeeping software or even a spreadsheet based bookkeeping system that you create is a good idea.
This is crucial not only to know how much you will owe for the end of the year once taxes are due, but you’ll also be able to quickly understand the overall health, profitability, and trends of the financial side of the business.
3. Keep all of your receipts
To be completely honest, I didn’t even consider this until after almost a year in business when I hired an accountant for the first time.
They asked me where my receipts were kept in case they or the IRS had any questions about my tax deductions based on my expense report. I looked blankly at them and said the now infamous…
“You’re supposed to keep those..?”
Don’t be like old me, keep every receipt you get from your business related purchases and if you don’t receive one make sure to request one from your vendor.
Even something as simple as tape can be used for a deduction come tax time and every penny counts to save your hard earned money.
My preferred method is to take a picture of all physical receipts, and download all online receipts, and upload them to google drive. But you can also use something like dropbox or a dedicated receipt tracking app as well.
Even though you aren’t likely to need these, it’s crucial that you can access them easily so I recommend storing them in folders by year, month, and transaction type.
4. Regularly set aside at least 30% of your income in your business checking for tax season
This lesson makes me shudder a bit everytime I think about it or give out this advice.
Why, you might ask?
Because when I first started freelancing, I thought all of my precious income belonged to me. Since I wasn’t making a lot of money I quickly spent most of my earnings on bills and other essentials without a second thought.
This was a mistake…a terrible terrible mistake.
You see, I had forgotten that since I was no longer an employee it wasn’t anyone’s responsibility to withhold taxes at the end of the year. I was now the only person who’s job it was to pay uncle Sam.
And I completely forgot to save any money for taxes. So a few months before my taxes were due, I had to completely empty out my bank account of all of my savings just to cover my owed taxes.
Don’t be like me.
Knowing that you have to pay taxes at the end of the year no matter what (although quarterly estimated payments are best), it’s good to get into the habit of saving up at least 30% of your freelance income to have at the ready come tax season.
In addition, you should use this simple tax estimate calculator to see how much you will likely owe each quarter.
5. Register your EIN
If you’re reading this thinking “what the heck is an EIN”, you’re not alone. I had never heard of one either but thankfully my bookkeeper told me I needed one right from the start during my free consultation.
EIN stands for Employer Identification Number and is used by the IRS to identify you for tax purposes. You can apply for and receive yours by following these instructions.
The main benefit of an EIN for freelancers is that you can utilize it for any tax related forms or payment requests, without having to enter in your social security number to identify yourself every time.
Second, if you are planning on forming an LLC, then it’s actually a requirement that you have one.
6. If you have business expenses and use your personal credit card, switch to a business credit card instead for further benefits
Sometimes as a freelancer it can be tempting to mix personal and business dealings because it feels more simple and requires less effort.
So for certain basic purchases like office supplies, or gas, it can seem easier to use your personal credit card and then try and remember to classify it correctly come tax time.
I find this approach to have a high likelihood of making a mistake.
The much better alternative, on top of your separate business banking accounts, is to get a business credit card.
When you pay for items that you need and will already pay for during the normal course of your business, it can be wise to use a business credit card to receive perks like cash back, free gas, or even heavily discounted travel.
What’s important to keep in mind is that you should only use this for necessary purchases, have it paid back automatically through your account, and choose a card with low or no fees.
Here’s a great list of some options that you have. Choose wisely.
Taxes and structuring your business like an actual business are extremely important.
These considerations and early decisions will directly contribute to the health of your business and more importantly, your well being. Take them seriously and remember to get as much help as you need along the way.
Also, I highly recommend you incorporate your business as an LLC. It’s a little more work, but worth it.