Have you ever had questions about how to legally start a freelance business?
If so, you aren’t alone. Most freelancers I talk to have lots of questions about the legal side of freelancing. They aren’t sure how to pay themselves, what business entity to choose, and how to track expenses.
Honestly, it’s a lot to learn, but we’ll take it one lesson at a time and you’ll get there.
So let’s talk about three biggest parts of the legality of freelancing:
- How do I legally start a business?
- How to I track my business income and expenses?
- How do I make taxes less painful? (because they are always painful, at least in some way).
But before I dive in…
I suggest that you talk to an accountant if you are worried about this topic. Each state in the US is different, and they all have different laws. And that means that this guide will cover the basics, your personal accountant can give you specific and personal advice. While a lot of this advice will stand for lots of the states, it’s always good to talk to an accountant. Yes it’s not fun, but it sure beats paying back taxes or going to prison.
Now that’s said, let’s talk about how to start a freelancing business.
1. How do I legally start a business?
For me, I live in Utah, USA. And when I started my business this is what I did:
- Have a legal business residence. This often will just be your home address, but you will need it for filling out forms and applying for bank accounts. (Free or Paid)
- Decide what business entity you will have (LLC or S-Corp) (Free)
- Apply for an EIN with the federal government. (Free)
- Apply for a state business license. (Paid)
- Apply for a municipal business license. (Paid)
- Obtain a business bank account (Free or Paid).
- Sign up for state unemployment insurance for your business. (Free to signup)
- Check if your state has any other legal requirements for starting a business.
And that’s the summed up version. Some of the steps here will be really easy (like picking a business address), but some are hard. And the hardest one is picking the right legal structure for your business.
So what are the different legal structures? And which one should you choose?
There are a lot of legal structures in the USA. There are trusts, corporations, sole proprietorships, and more. But for the purpose of freelancing I’ll only mention 4 of them:
- Sole Proprietorship
- Corporation (C-Corp and S-Scorp)
- Limited Liability Company
A sole proprietorship is where you are your business. They are easy to setup and easy to use. But there are downfalls. First off, if your business gets sued then you are personally liable. That means that your personal assets (home and car) are at risk if someone sues you. With this option you will also pay full self-employment taxes (as opposed to an S-Corp where you only pay on you ‘reasonable salary’. In general, do not choose this option for a freelance business.
A partnership is like a sole proprietorship but there are two people who own the business. True there are different types of partnerships, but this entity is still liable just like the sole proprietorship. You might choose this one if you go into business with a friend, but a LLC or S-Corp would give you more protection. In general, do not choose this option either.
A Limited Liability Company is one of the most common business entities. It gives you a good range of liability protection and isn’t too hard to setup. You will need to draft up Articles of organization, but this is an all around good choice. Lots of people run an LLC, and it will serve you well.
Then we have corporations. A C-Corp is what big companies use and you’d almost never use one for a freelance practice. But an S-Corp is awesome. There are some great tax benefits of running an S-Corp, and you still get the liability protection that a corporation provides. Most full-time freelancers I know choose an S-Corp, but an LLC is still very common. For me, I chose an S-Corp. It allows me to set a ‘reasonable’ salary, and only pay medicare and social security based on that salary.
Overall, I suggest that you: First, talk to an accountant to be sure of your specific state laws. And Second, that you choose either an LLC or an S-Corp. Both give you liability protection, and either are a good choice. I chose an S-Corp, but and LLC still is a great choice. It all depends on how you want to be taxed. And if you still have questions, a good accountant can set you straight.
2. How to I track my business income and expenses?
First off, you should have a business bank account. You want to keep your personal earnings and your business earnings separate. This means when you get paid, your revenue goes into a business bank account. And from that business bank account you write yourself a check (which feels strange the first time you do it) and pay yourself whatever you want.
And getting a business bank account is easy. You just need to show them proof that you own that business (like showing them articles of incorporation), and proof of who you are (like a driver’s license).
Next, you’ll likely want to use some software to keep track of your business expenses. For me, I use Quickbooks and it has served me well. It isn’t perfect software, but it does work and most accountants are familiar with it. Yet Freshbooks is a valid competitor, and lots of freelancers choose it. It even has invoice reminders that ping your clients to remind them about late payments. In the end, both should serve you well, so check out both of them and see which one works for you.
The best part about using software to track your income and expense is that you can see at a glance where you spend your money on. You can see what categories appear to be too high, and which ones are lower than you thought. So if you are using paper I suggest that you upgrade to a software package. It will make things easier throughout the year and makes taxes more simple.
3. How do I make taxes less painful?
Taxes are painful.
There is no way around it. But you can make them less painful. There is a quote by Dante that says “The arrow seen before cometh less rudely.” And it’s the same for taxes. You know every year taxes will be coming, so here’s what you do to make things easier.
First, make sure you keep track of your business revenue and expenses. This will make tax time that much easier. This means staying on top of your finances. And the best way to do this is to work on them regularly (I do mine once or twice a week).
Second, make sure that you save a percentage of your income. How much depends entirely on how much you make, and how many deductions you have. If you make $80,000 per year, are married, have some kids, and have a lot of deductions then you might want to save 10-15% of your revenue. If you are single, make over $100,000, and don’t have any kids then you might want to save 30%.
For me, I have two kids, I’m married, have a mortgage on a house, and so my tax amount isn’t too bad. I saved 10% of my income, and that 10% paid for my federal taxes, state taxes, and my self-employment tax (medicare and social security). And it was a relief to have that money saved away.
So for you, I suggest that you save 25% of your income each month. That will give you a solid buffer and help make things easier when taxes are due.
Third, hire an accountant. There is no shame in hiring an accountant. A good one is worth their fee, and if you shudder at the thought of bookkeeping then don’t do it yourself. Pay someone to do it for you.
And taxes aren’t really that bad. Yes, they are a pain, but by tracking your finances, putting money in business savings, and hiring an accountant can all make it easier.
Starting a business can be daunting. But it doesn’t have to be. First you can use the list above as a guide to help you start your business. Second, make sure that you track your revenue and expenses. And third, prepare beforehand for tax season. By staying on top of things throughout the year you can make tax season easier and less stressful for you.
And if this still seems hard please talk to a skilled accountant. There is no shame in it, and they can help you get off the ground running so you can work on your business.
P.S. If you want to start freelancing you have two options. You can wait, patiently, while I post new articles. Or, if you want to start freelancing and earning money this week, I have a course you can take. By taking the course you’ll learn how to specialize, how to find clients, and how to price your services. So sign up now, and I’ll teach you how you can earn more money freelancing and have more time to do what you want to do in life.