If you stay in the freelancing game for a while, you’ll soon start to notice your peers talking about business expenses, accounting and self-employment taxes. And before you know it, they may even tell you that they want to start a sole proprietorship, LLC or S-Corporation. The first time you hear fellow freelancers talking about taking this major step, you may think they’re crazy. But the more immersed you become in the freelancing world, the more you’ll realize that having an official business is actually normal for freelancers.
Of course, if you decide to establish your own business, you’ll have to determine which type of entity makes the most sense for you. Here, it’s important to remember that officially setting up a business can cost a lot of money — sometimes $1,000 just to file LLC paperwork. Then you have to deal with the costs of annual reports and the hassle of paying quarterly tax estimates ahead of tax time. In many ways, a sole proprietorship may be a better option for new freelancers. They’re easy to set up, low cost and still help you cover all the bases of doing business legally. Here are four reasons why a sole proprietorship may be a great option for you.
1. Little to No Paperwork
Because a sole proprietorship is the responsibility of its proprietor and isn’t set up as a separate legal entity, you don’t have to do nearly as much paperwork. Once you complete the “doing business as” (DBA) paperwork at your local county clerk’s office, which lets you “do business” as a name that isn’t your own legal name (or keep your name for yourself if you think someone else might take it), nothing additional is required from you — even when tax time comes around. Down the line, you’ll just have to report the business income on your own personal income tax forms, and that’s it.
“When someone becomes self-employed,” explains Laura Shin on Forbes, “the default business structure will be sole proprietorship, in which the self-employed person will report her business income on her personal tax return.” If you’ve been doing work for clients and haven’t done anything “official,” you’re already operating within the sole proprietorship model.
“Depending upon the city or municipality where you set up shop,” advises Inc., “you may need to register your business or obtain business and/or occupancy licenses.” Call your local Small Business Association for more information regarding your specific situation.
2. It’s Inexpensive
When I filed the paperwork for my LLC, I paid $750, which is considered low. But for freelancers who aren’t yet earning a full-time living from their freelance work, the price of an LLC might be totally out of the question. Additionally, I have to file a “report” with the state every year that costs $200, just so they won’t administratively dissolve my business.
To start a sole proprietorship, you don’t have to pay these massive fees. In fact, the only thing you really have to pay for is the DBA. And the cost of filing a DBA typically ranges from $10 to $100.
3. No Recurring Fees
With an LLC, you have plenty of recurring fees. Not only do you have to pay quarterly taxes in advance and pay an accountant to figure out those estimates for you, but you also have to pay to file an annual report every single year. And if you don’t, the state will dissolve your business. I know, because it happened to me. But as the owner of a sole proprietorship, you won’t have to suffer through any of these recurring fees to keep your business going. Once you pay for the initial paperwork, you’ll be good to go.
4. You Get to Deduct Business Expenses
When you have a sole proprietorship, the business’s expenses are your expenses, too — so they’re deductible. Anything you purchase for your business, like a new laptop or design software, counts as a business expense and can be deducted from your total income come tax time. But since so many self-employed individuals are audited, and a lot of these audits involve disallowing deductions because the IRS decides to classify a “business” as a “hobby,” it’s crucial that you have the right paperwork in place.
“As a small business owner,” says CPA Alicia Sisk-Morris, “it is your responsibility to make sure your business is viewed as a legitimate business in the eyes of the IRS, and not a hobby.” To do this, she suggests that you:
- Determine your specific legal structure
- Keep your business and personal finances separate
- Have a business website
- Keep your business documents organized
Sole Proprietorships Make a Great Starting Point
If you’re just starting out as a freelancer and don’t have the cash to spare, doing business under the sole proprietorship model can be a great place to start. But keep in mind that a sole proprietorship isn’t labeled as a separate entity with the government, which means you don’t have the same legal and financial protections as you would with other business models. For example, if your business gets sued and you have a sole proprietorship, your personal assets won’t be protected. Your house and car could still be up for grabs. For the vast majority of freelancers, this is never an issue. But it never hurts to have those legal protections in place once you can afford to have them. “If you anticipate making more than $30,000 in net-income before year-end, [you should] consider the S-Corporation, [instead],” says small business tax and legal expert Mark J. Kohler.
Overall, it’s important to consider a variety of factors before you decide which type of business entity to pursue. Be sure to think about the tax treatment you seek, as well as your ability to raise capital and the type of liability protection you need. Could a sole proprietorship be right for you?