The Business of Freelancing – Picking a Legal Form of Business
This is the fourth day of our series on The Business Of Freelancing. Every day this week we will have a new tip to help you make the most of your freelancing career.
If you missed the previous posts, check out Saving For Taxes,You Are In Business To, and Creating a Business Plan: How Will You Make Money? For more, check out ShaneandPeter.com.
Picking a Legal Form of Business
What legal form of business is best for you? This is important to consider carefully as it has many implications for your future. For some it is a sole proprietorship, for others it will be an S corporation or an LLC. Over the years, Peter and I have owned sole props, general partnerships, and S Corporations. Don’t think that because you picked one you are trapped, you can change (it’s just a pain), but picking one is an important step in defining exactly what your business is.
First, let’s state the two most important factors that you’ll take into account when finding your business form.
- Liability. What is my business (freelancers, this means you) responsible for? How much risk does my business place me in? Do I have personal assets that I want to protect?
- Taxes. Based on expected income, what form of business will save the most on taxes? Or rather, will one form of business offer me tax savings over another?
I picked a sole prop first because it was simple. I wasn’t too worried about liability (because I owned nothing and I wasn’t doing high risk services). The paperwork was relatively straight forward (I didn’t need a lawyer) and the cost was in my price range.
When Peter and I joined forces, we set up a general partnership. The GP was basically the same as the sole prop, but for multiple people. We laid down a few rules, a partnership agreement saying what happened if any of us wanted to leave, died etc… and we were off. I recommend using a lawyer for the partnership agreement and checking with a CPA. In a general partnership you are completely liable for the actions of any and all business partners. As a result, this is the most exposed of the options.
Over the last couple years, by taking larger projects we increased the potential for liability (if things went boom). We took on the responsibility for a team of contractors. We bought our own homes. In short, because we had upped the ante on projects and our own personal property, we were at significant risk if things were to go awry. Our legal and financial counsel agreed it was time to set up a corporation. It involved about a month of planning and paperwork, a few hours of a lawyer’s and CPA’s time and some local and state fees, which all together cost a few thousand dollars. At the end of the process, we had a viable S-Corporation, which among other things, helps protect us personally from business liability.
How do you decide? First of all go read my post on the business types. It’s a bit thick but if you read slowly it will help. It pretty much comes directly from our lawyer’s mouth with a few liberties of our own. Then sit down with a CPA and a lawyer to discuss your particular situation.
Once you have decided on your business legal structure, then partnerships, corporations and LLCs will need to file the proper form with the Secretary of State. Corporations will often have to file tax forms with the Franchise Tax Board. You might also want to check with the IRS on your federal tax schedule.
This is a serious and vital step for any freelancer to make. It needn’t be intimidating though. If you haven’t done so already, run a search for your state’s business filing rules.
NB. This information should augment, not replace advice from an accountant or lawyer. This information is mostly relevant to US citizens. While we would like to include information for more localities, because FreelanceSwitch readers hail from all over the world this cannot be accomplished.
Stay tuned for tomorrow’s post, Bookkeeping – The Difference Between Profit and Loss.
Original post by Shane