If you’re just starting out in the world of freelancing, chances are you’re feeling a little overwhelmed by all the choices and potential paperwork. What should you name your business? How do you file taxes? How should you structure your business?
A sole proprietorship is the easiest and cheapest way to get started, as it makes no distinction between you and your business. In fact, if you are doing business and haven’t registered as a specific business structure, you are already considered a sole proprietorship, filing your taxes with your social security number.
Registering your business as a Limited Liability Company (LLC), on the other hand, provides an extra layer of protection between you and your business, particularly when it comes to finances. As such, it’s a bit more complex than a sole proprietorship.
Although there are both single- and multi-member LLCs, we’ll be focusing mostly on single-member LLCs for the purposes of this article, since it is the preferred structure for freelancer and small business owners with no employees.
Single-Member LLC vs. Sole Proprietorship
In some ways, a single-member LLC and a sole proprietorship are similar, but there are a few important distinctions.
In both cases, your business is not required to pay corporate taxes. Instead you’ll pay self-employment taxes. And for the income tax, you’ll file as a self-employed individual.
However, since an LLC is more formal than a sole proprietorship, there are greater upfront costs, more requirements you’ll have to meet and maintain — such as the one-time filing fee and subsequent annual fees (exact amounts vary by state), any state-required licenses, strict separation of business and personal finances, etc. — and more steps you’ll have to take before you can officially get started. But you’ll also have greater protection in place for your personal assets.
Why Is it a Good Idea to Register as an LLC?
Despite the extra paperwork and cost, an LLC affords you more protection than a sole proprietorship does. You are required to keep your business and personal assets completely separate, but that means your personal assets are safe if the business is sued or accrues debt. For example, in the past, you had to open two bank accounts, one for your personal use and one for your business use. But with Lili, that is no longer the case: you can open one account both for you and your single-member LLC, and keep all your finances separate within the app itself.
An LLC also gives you more credibility as an established business. It’s more formal than a sole proprietorship, which can make a big difference if you need to apply for any loans.
How Do I Register an LLC?
Requirements vary by state, so be sure to read up on the specific requirements for your state of operation. It is technically possible to register your LLC in a different state than the one in which you plan to operate, but in that case you’ll also have to register as a foreign LLC in your operating state, which could lead to more headaches than benefits.
When you register your LLC with the state, you’ll need to pay the state filing fee, which can be anywhere from $40-$500. Depending on the state, you may also be required to pay additional fees for licensing, permits, publication, and/or name reservation. Your business name can be the same as the name you register your LLC under, or you can designate a “doing business as” (DBA) name for it instead.
Whether you choose to register your LLC on your own or hire a professional service, like LegalZoom, to help you navigate the process, most states also require you to appoint a registered agent as your legal point of contact. This agent will receive legal documents such as tax forms and official government notices on your business’s behalf. Additionally, you will likely need an operating agreement, which sets in writing the specific rules of how your LLC will operate, and an Employer Identification Number (EIN), which can be used in place of your social security number to identify your business for tax purposes.
Finally — once again, depending on your state — you may be required to pay annual fees for franchise tax and annual reports.
So why go to all this trouble and expense to register an LLC instead of simply registering a DBA, if both provide a layer of separation between you and your business? In short, because the only separation a DBA provides is a different name. Legally, if you only have a DBA and not an LLC, you can still be held personally liable for any business debts or lawsuits. An LLC, on the other hand, guards your personal assets by keeping them completely separate from your business assets.
Protect Yourself & Your Business with an LLC
While registering as an LLC isn’t absolutely necessary to do business as a freelancer, it does protect you by setting a clear divide between your business and personal finances.
Of course, that also means you must be careful to maintain that divide and avoid intermingling expenses and income between your business and personal accounts, or you’ll put your personal assets back at risk.
For help managing your business finances and reporting, check out Lili’s Tax Optimizer.