Many freelancers work exclusively through marketplaces such as Upwork and Fiverr, pocket the little money they manage to make into their personal bank accounts, and continue freelancing for years without setting up a real company. So, is freelancing a business, really? Why should you turn your freelance gigs into a separate legal entity for business purposes?
And why is it that all notable career freelancers do the exact opposite, i.e. set up a Limited Liability Company (LLC), typically after realizing a sole proprietorship (a business under your own name) isn’t enough? I’d claim that if you haven’t formed a company, you’re likely to work for peanuts… which is fine if freelancing is a little side gig thing every now and then.
Real freelancers form a proper business entity. Here’s why it pays off and increases your profits once you’re in the Coconut Class of career freelancers.
Business… what business?
Many freelancers choose not to form a separate business entity like a sole proprietorship or LLC for various reasons, often driven by perceived simplicity and cost considerations. For those just starting out, the idea of setting up a formal business structure can seem overwhelming and unnecessary, especially when their income is still modest. The administrative tasks, such as registering the business, maintaining records, and filing separate tax returns, can appear daunting and time-consuming.
Another key reason is the cost. Establishing an LLC, for instance, involves state filing fees and potentially ongoing annual fees, which can be a deterrent for freelancers trying to minimize expenses. Some may not fully understand the benefits of forming an LLC, such as liability protection and tax advantages, leading them to stick with operating as an individual.
Additionally, freelancers might assume that their business is too small or low-risk to warrant the effort of creating a formal entity. They may also lack awareness of the legal protections that an LLC offers, mistakenly believing that as long as they manage their finances carefully, they don’t need the separation between personal and business assets. As a result, they continue to operate informally, potentially exposing themselves to unnecessary risks.
Why having an LLC is a good idea
Separating your personal and business finances by forming an LLC is a smart move because it protects your personal assets from business liabilities. With an LLC, your personal savings, home, and other assets are generally shielded if your business faces legal issues, debts, or bankruptcy.
This gives you several benefits that you won’t get if you keep your freelance “business” as a little income category on your personal bank account.
Taxation advantages
This separation of your personal and business finances simplifies financial management, making it easier to track income and expenses, which is crucial for accurate tax reporting and compliance. Imagine your tax authority asking for financial statements or other documents for a random tax audit! There you go, submit your personal account details and try to mark what among all the transactions relates to the business and what does not.
This actually happened to me once… I was asked to submit a report showing a specific expense category with all transactions. Fortunately, I did have a business name and a business account in my bank. Extracting the report was easy! Otherwise, it would have been a small nightmare.
In the United States, there are a couple of benefits to forming an LLC for bundling your freelance gigs as a separate business:
1) Deduction of business expenses: As an LLC (or as a sole proprietor), you can deduct a wide range of business expenses, such as home office costs, equipment, travel, and professional services. These deductions reduce your taxable income, lowering the amount of tax you owe.
2) Pass-through taxation: An LLC allows for pass-through taxation, meaning the business itself doesn’t pay federal income taxes. Instead, profits “pass through” to the owner’s personal tax return, avoiding the double taxation that corporations face. This can lead to significant tax savings, especially for freelancers with higher incomes!
3) Self-employment tax flexibility: LLCs taxed as S-corporations can help freelancers save on self-employment taxes. By paying themselves a reasonable salary and taking the remaining profits as distributions, which are not subject to self-employment tax, freelancers can reduce their overall tax burden.
A quick consultation with your tax advisor will be worth the money if you reap the benefits of a 10-20-year freelancing career.
Where freelancers usually go wrong from the start, is not understanding the meaning of “business expense”. Did you have a lunch with a client and paid for it? Business expense! Did you buy a new laptop (mainly) for work? Business expense! Did you have to pay banking fees to receive the money for your contracts? Business expense!
Only idiots would pay for all those from their own pockets with their taxable income. These things really stack up! Deduce your expenses from your revenue first to see your profit. Your taxable income is not based on your revenue but on your profit. Big difference!
Other advantages
Additionally, there are several other benefits besides taxation.
4) Professional image: Having distinct business accounts enhances your professional image, helping you secure business loans and build credit. Freelancers may not face such situations, but as your business grows, why exclude such an option by your own actions? Perhaps not.
More importantly, having an LLC helps build credibility as a professional as seen by your clients. When a mid-size company is looking for a credible sub-contractor, would they go to someone who doesn’t even have a business name to be put on the contract or would they rather talk to someone who is a “Chief Executive Member” of a single-member LLC, a business owner just like the client?
5) Easy management: Maybe you think that managing a company is difficult and time-consuming. LLCs are relatively simple to set up and manage compared to corporations, with fewer compliance requirements and more operational flexibility. Mainly, you need to do your books properly and file your taxes correctly. How you do it and what else you do – nobody cares!
And now that your personal bank account and business account are separate, bookkeeping gets easier, not harder, actually!
The management effort is nothing like a Private Limited company, the business form large corporations use. You don’t need to worry about the management effort.
6) Banking: Forming an LLC can provide access to business banking accounts, credit, and other financial products, as well as eligibility for business grants and funding. I can honestly tell you that having a Mastercard only for business purposes makes things so much easier than trying to use your personal card, reimburse yourself every time, and so on. So, again, things get easier, not harder!
7) Perpetual Existence: Perpetual existence is a key advantage of an LLC that sets it apart from a sole proprietorship. In a sole proprietorship, the business is directly tied to the owner, meaning it typically dissolves if the owner retires, leaves, or passes away. However, an LLC is considered a separate legal entity, allowing it to continue operating independently of the owner’s involvement.
This ensures that the business can maintain its operations, fulfill contracts, and preserve its value, even in the event of the owner’s departure or death. This continuity provides stability for employees, clients, and business partners, enhancing the long-term prospects of the business.
When freelancing is a career and you perhaps acquire a good set of subcontractors or level up the business to an agency, perpetual existence starts to matter.
Overall, an LLC provides both financial protection and operational clarity and is crucial for long-term business success even as a freelancer.
Is freelancing a business to you?
So, what’s it gonna be in your case? A little bit of freelancing under your personal name or a true business as an LLC owner? If you choose the latter and wish to have a permanent business arrangement in the United States, you can do what I did: Form a company via FirstBase! You get:
- Company formation documents
- Company secretary that is required by law
- Bank accounts with direct invoicing features
- Legal business address with a mailbox and mail forwarding service (so you actually get your physical credit card)
- Tax filing service
- Hundreds of discounts on affiliate services that most business owners need (e.g. accounting)
Sounds like a lot? It is!
At the time of writing this, it’s been almost 3 years since I made this move. And for practical arrangements regarding how to run a business, it’s been great for:
- Banking
- Financial management & bookkeeping
- Legalities & compliance (yes, believe it or not!)
- Client relationships (my US clients love not needing international wire transfers!)
- Taxation
And a couple of minor things. But the last one made a really big difference. My coconuts just keep multiplying!
FirstBase is an easy way to set up an LLC in the US.
If you’re interested in leveling up your freelancing by forming a single-member LLC in the US as your personal “offshore” company, I may be able to help you get through all the hurdles without wasting any time not knowing what to do when and in which order. Connect and send me a message on LinkedIn!
