Freelancing is an interesting occupation.
A lot of us start out picking up freelance work to pick up some extra money, because we wanted a part-time gig, or for more flexibility in how and when we work. As a result, even if you’ve shifted to making your full-time income from freelancing, you might not think of yourself as a business owner.
Guess what? You are.
Even if you’re just starting out and only billing a few hundred dollars a month, the minute you start charging clients, you are a full-fledged professional.
Of course, business ownership comes with some responsibilities and legal matters to attend to. If you’re a freelancer, and you don’t know whether you are a sole proprietor or an LLC, more than likely you’re just a sole proprietor. So what exactly does this mean? And why should you change your freelance business from sole proprietorship to LLC? Let’s dive in.
Sole Proprietorship vs. LLC
Legal jargon can sound scary if you aren’t familiar with it, so let’s quickly define these words.
A sole proprietorship just means you have a business that is run by a sole–or single–person. So if it’s just you and your clients, and you’ve never done any legal paperwork to set up a business, that’s you.
An LLC can also be a single-owner business, but it’s different because an LLC (which stands for limited liability company) is an entity unto itself. In other words, the LLC exists separately from you as a person.
In practice, when they have just one owner, an LLC and a sole proprietorship operate essentially the same way. You still make the decisions, book clients, do the billing, etc.
So why would you go through all of the trouble of shifting models from sole proprietorship to LLC? Because along with all the paperwork, an LLC has some clear benefits:
- Forming an LLC separates your business from your personal assets, so it gives you some protection if something goes wrong.
- An official LLC gives you access to lines of business credit in a way that a sole proprietorship doesn’t. If you’re taking on large business expenses, like computer equipment or renting a work space, this can be crucial in helping you get started or expand.
- Incorporating as an LLC gives you professional credibility. This likely doesn’t matter at the beginning of your freelance career, but as you take on more serious and larger clients, having the legal framework to back you up can really make a difference in winning bids.
- An LLC can grow with you, should you decide to take on a partner or employees at some point.
That’s not to say that making the change from sole proprietorship to LLC is always better. It is definitely more complicated to work through an LLC, and there are a few additional fees to pay. But the advantages are worth weighing.
3 Steps to go from sole proprietorship to LLC
At this point you may be wondering, is it even possible to make the jump from sole proprietorship to LLC? It definitely is. And any business owner can do it.
The process varies a bit from state to state, so make sure you check out the laws in your area, but here are a basic set of guidelines:
1. Pick a name
If you already have an official trade name, you will need to cancel it. You might be able to reuse it, but LLCs have a specific set of guidelines to follow.
Obviously, you can’t use official terms like “bank,” that make people think your business is something it’s not. And in some places, you can’t use words that make your company sound like it’s affiliated with the government, like “city” or “village.”
Do your research–some words are prohibited that might surprise you. For example, you cannot use the word “trust,” in any form, because that is a legal term with financial implications.
You may not plan on using the name of your LLC as the masthead on your website, but still take your time choosing something memorable, meaningful, and works to your advantage for SEO and social media purposes.
You don’t know what the future holds, and you want an LLC name that you are excited and proud to use for years to come.
2. File articles of organization
This is a fancy term for the legal papers you need to fill out and submit to the state to make your move from sole proprietorship to LLC official.
You can get the proper paperwork through the office of the Secretary of State in your state, through a form site like LegalZoom, or through an attorney.
When filing the paperwork, you need to choose a registered agent. This is the person responsible for all legal decisions. Usually that will be you or your attorney.
You will also need a physical address for your business. For freelancers, this is often the same as our home address. You may not want to give out that kind of personal information, because the articles of organization are public record. So, you might consider looking into a P.O. box before you file.
3. Make it official
The final step in creating an LLC is to embrace it and start doing business as an LLC.
This means, to begin with, updating all of your paperwork. Every contract, invoice, or any kind of registration you use has to be in the name of your new LLC. You’ll also want to include it somewhere in the fine print on your website.
And most importantly, you need to create a business bank account for your shift from sole proprietorship to LLC to be valuable. As a sole proprietor, you can use your personal account to deposit checks and pay our expenses. But to have the liability protection of an LLC, you have to have a separate account that you use for business, opened in the name of your LLC.
Determining what is right for you
Now that you know the ins and outs of what an LLC is and how to create one, how do you decide if you want to change from a sole proprietorship to LLC?
For most freelancers, it makes sense to start out as simply a sole proprietorship. You can get started right away with no business fees, and you can see how things go.
As you grow, however, it’s time to think about protecting yourself and moving to an LLC structure. We have discussed the benefits of an LLC, but there are also some minor disadvantages to consider when you are still a small operation.
First of all, the fees to set up an LLC vary state to state. If the fee is small where you live, then this isn’t a problem. But in some states, there can be large setup fees, and/or an annual operating fee. Paying hundreds of dollars per year when you are working on the side and not likely to come up against legal problems probably doesn’t make sense.
Secondly, the additional paperwork involved in operating an LLC can include your tax filing. As a self-employed individual, you’re already filing a slightly different form than traditional salaried employees.
As an LLC owner, you can choose whether you are taxed as an individual or whether the LLC is taxed as a separate entity. Discuss this choice with your accountant before filing articles of organization to ensure you are setting everything up in the way that helps you the most.
If you want to know more about the advantages to each business structure, Incfile has created a helpful video:
As freelancers, it’s tempting to ignore the leagaleeze of running a business.
The terms can be confusing, there are lots of numbers involved, and it sounds boring.
There’s a reason most of us didn’t go to law school, right?
Eventually, there comes a point when it’s critical to start thinking about the way your freelance business will grow and change. As you start to generate more income and work with more varied and larger clients, it’s time to consider changing from a sole proprietorship to LLC status.
You may think you don’t need the legal protections an LLC offers. But freelancers can get sued just like anyone else.
Some of the big gig economy exchange sites have sued solopreneurs for violating their terms of service. And it isn’t unheard of for angry clients to go after a freelancer when they don’t like the work that was delivered or if there was some kind of security breach.
You can even be held liable for lawsuits from clients competitors if you are creating public-facing work like marketing materials.
Creating an LLC is a way to plan for the best, but prepare for the worst. Far from feeling overwhelmed or afraid, this opportunity should give you a sense of pride.
You’re doing it–you’re a full-fledged, grown-up business owner.
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