The day you earn money freelancing is the day you officially become a business owner in the eyes of the law. That comes with all sorts of weird responsibilities, and it makes most new freelancers wonder if they need an LLC. The short answer?
Freelancers in the United States do not have to register as a Limited Liability Company (LLC) because they automatically operate as a Sole Proprietor (SP) business when they start to take paid freelance work. However, a properly structured LLC can help protect the freelancer and their assets from damaging lawsuits, avoid double taxation, and establish credibility in the eyes of people who consider doing business with you. An improperly structured LLC may not provide any protection at all.
In other words, you don’t have to file an LLC to operate a freelance business, but it can help you keep the clothes on your back if you set it up right.
We’ll talk more about that in a minute, but first I have to tell you I am not an attorney and this is not legal advice. Please speak with an attorney to make the decision that is right for your business. Alright, now let’s dive into the topic!
Table of Contents
- What is a Limited Liability Company?
- Do Freelancers Really Need an LLC?
- What Are the Types of LLC?
- Is an LLC Better Than a Sole Proprietorship?
- How Can Freelancers Maximize Their LLC Protection?
- How Much Will it Cost to File an LLC?
- What Are the Exact Steps to Register an LLC?
What is a Limited Liability Company?
Anytime you sell stuff in the U.S. you automatically become a Sole Proprietor business. You don’t have to file anything. You don’t have to register anywhere. You just start operating as a business. This is totally okay as long as you don’t mind putting all of your money and everything you own at risk.
LLCs exist to help protect small businesses and their owners. Not only do they help protect you from getting sued, but they also help you avoid double taxation while looking more credible as a business.
LLCs aren’t the only type of legal entity for businesses, but they are one of the most common types for small business owners and freelancers because they are relatively easy to register and set up.
Do Freelancers Really Need an LLC?
Most freelancers would be wise to form some kind of legal entity other than a Sole Proprietorship. The IRS is known to audit Sole Proprietors at higher rates than other types of businesses, likely because Sole Proprietors tend not to operate as professionally as other entity types.
As an LLC you can potentially distance yourself from the risk of lawsuits. A properly structured LLC separates the owners assets from the business assets. That means if some client tries to sue you, only what’s in your business is at risk, and technically there are ways to protect your business assets too.
The key benefit of an LLC is that when you do it right, you can sleep easy because your bed won’t be sued out from under you!
What Are the Types of LLCs?
There are three main types of LLCs and they each have benefits and disadvantages. Again, this is where you should consult a professional adviser or attorney to help you determine which type is right for you.
Types of LLCs
|Single Member LLC||An individual registers an LLC and chooses either to be taxed as a sole proprietor or as corporation|
|Multiple Member LLC||Multiple people register an LLC and choose to be taxed as a partnership or as a corporation|
|Series LLC||A company creates a primary (umbrella) LLC and registers “series” LLCs under it for additional protection.|
The type of LLC you need for your business will depend on the size of your business (is it just you or do others have a vested interest in the business?). It also depends on how much protection you want, and how far you are willing to go to get it.
Is an LLC Better Than a Sole Proproprietorship?
A Limited Liability Company can be better than a Sole Proprietorship for freelancers, but only when you set it up properly and follow best practices to keep yourself out of trouble.
There’s a misconception that once you register an LLC you’re protected from everything, even as a Single Member LLC. The truth is, if you don’t operate as a business, then an LLC only provides the illusion of protection.
For instance, some people form LLCs but don’t register a separate bank account for their business finances. They freelance for extra cash and then dump that cash into their personal bank account and use it for personal expenses.
That’s not a big deal until a client decides to sue the freelancer for ditching halfway through a project. Now a judge has to decide if the freelancer qualifies for the protection of an LLC or not.
If the freelancer operates as a business, then they may enjoy the full protection of their LLC and only their business assets are at risk. However, if the freelancer acts more like a Sole Proprietor, then a judge may rule that they do not qualify for the protection of an LLC because they have not operated as an LLC.
Now the freelancer becomes personally liable for damages. When this happens, it is called piercing the corporate veil.
How Can Freelancers Maximize Their LLC Protection?
Freelancers can help strengthen their corporate veil by taking certain steps that help them look and act more like a business that meets the criteria for an LLC. Here are some of the most important steps you can take.
1. Set Up a Business Bank Account
The easiest way freelancers can prove they operate as a business instead of an individual is to separate their business finances from their personal finances. To do that you set up a separate bank account that is only for business stuff. Creating a business bank account provides a number of other benefits.
Benefits of a Separate Bank Account
|Track business finances||This gives you an easy way to know how well your business is doing at any given time. Since you don’t have to sort through your personal finances compared to your business finances, it just makes life easier.|
|Qualify for deductions||A separate business account helps you avoid being classified as a hobby business by the IRS in the event they audit you while potentially enjoying tax deductions that aren’t available to other types of business entities.|
|Credibility||When you establish a bank account in the name of your business, you look more credible as a business. For instance, checks you write will have your business name on them. Credit card transactions and other invoices may also have your business name on them.|
Technically speaking, all freelancers should have a separate bank account for their freelance business. Even if you operate as a Sole Proprietor, you should keep business finances separate from personal finances.
If you don’t qualify for a business bank account, then it is okay to open a second personal bank account that is only used for business finances. As long as they’re separate, then the account may still be considered a business bank account.
2. Get an Employer Identification Number (EIN)
Your EIN is like a Social Security Number (SSN) for your business and it’s free. The benefit of an EIN is that it creates another level of separation between your business and personal identity.
Here are some other benefits:
- An EIN separates your business and personal identities
- It allows you to hire employees
- Allows you to set up a Keogh retirement plan
Once you file for an EIN, you will use it on all of your business documents where you would normally have to use your SSN. This shows the world that you are Bob’s Big Burgers instead of just Bob.
Your EIN also allows you to hire employees, and you need it in order to withhold taxes on income that isn’t wages for non-resident aliens.
Those working on a retirement strategy who plan to use a Keogh retirement plan need an EIN because it is required of the self-employed and other non-incorporated businesses.
3. Purchase a Business License
You may not need to get a business license depending on your location and type of business, but the more separation you add between yourself and your business identity the better. The whole idea of strengthening your corporate veil is to show that you are a business, not an individual.
A business license helps establish you as a business in your local area. It tells other people that you are not just Bob, but you do business as Bob’s Big Burgers locally. This can also be important for tax and legal requirements. For instance, some states, such as Washington, can issue fines if you do business without a business license.
Freelancer or not, you may need a business license when:
- Operating in another city, county or state
- Hiring new employees
- Selling new products or services
- Opening additional business locations
- Closing a business location
To purchase a business license, check your local city and county websites to find out where to go to register your business and when a business license is required for your specific location.
3. Use an Operating Agreement
Your operating agreement describes how your business operates and the roles each individual plays within it. Not all LLCs are required to have an operating agreement, but you should have one and keep it updated even if it’s not required.
Operating agreements are minor business formalities, but they can make a big difference in how a court perceives your business. When you use an operating agreement, and update it at least annually, then you show additional business structures that most Sole Proprietors don’t have.
Another reason to have an operating agreement is that without one your business defaults to the state’s LLC rules where your LLC is registered. Some state’s rules are not very friendly to LLC owners, and could put you and your business at great risk without a formal operating agreement.
An operating agreement can be as simple as a Google doc typed up by you that describes how your business operates, who runs it, and its daily functions.
To get the most protection, you’ll want to check out your state’s Secretary of State website to better understand their operating agreement procedures. Additionally, it is worth it to consult an attorney or other professional advisers.
5. Hire a Registered Agent
Every LLC requires a registered agent. A registered agent is the person or entity who serves as the point of contact between the state, other businesses and your business.
The registered agent for your business can be yourself if you reside in the same state as your business. It can also be a member of your business in some situations. In other situations, such as when you register an LLC in another state, you will need to hire a company to act as your registered agent.
Some situations that make sense to have a registered agent:
- Your LLC is registered in another state from where you reside
- You don’t want to track or handle business paperwork
- You work weird business hours or are regularly out of office
- You use a P.O. box as the main address for your business
- You don’t want other people to have your personal address
A registered agent receives important business communications on your behalf. When you live in another state from your LLC, you need a registered agent to receive mail such as court documents for your LLC.
When you don’t spend a lot of time in your office, or you work strange hours, then you can miss really important pieces of mail and other business communications. A registered agent can handle those for you.
Limited Liability Companies and their registered addresses are also a matter of public record. If you don’t want everyone in the world to have the ability to figure out where you live, then it makes sense to use a registered agent in place of your personal address.
To get a list of registered agents for a particular state, check the state’s Secretary of State website.
How Much Will It Cost to Register an LLC?
The price differs from state to state. The table below shows the prices by state as of this writing as provided by NOLO.com.
|State||Filing Fees||Ongoing Fees|
|Arizona||$50||$0 to $100|
|Arkansas||$45 or $50||$150|
|District of Columbia (D.C.)||$220||$300|
|Missouri||$50 or $105||$0|
|New Jersey||$125||$125 per member + $50|
|New York||$275||$25 to $4,500|
What Are the Steps to Register an LLC?
The steps to register a Limited Liability Company differ from state to state. To ensure you get the most accurate and up-to-date information on how to register your LLC, visit your Secretary of State’s website (links below).
Is it Worth it for Freelancers to Register an LLC?
The amount of risk you’re willing to accept is always up to you. Some people don’t worry much about risks as a freelancer and prefer not to pay the fees or spend time learning about the benefits of an LLC or how to set one up.
That said, whether you form an LLC or some other business entity, it really is worth considering just how much you put at risk by operating as a Sole Proprietor.
We’re talking about potentially losing everything you’ve built. Not just what you’ve built into your business, but also in your personal life. Operating as a Sole Proprietor is certainly easier than going through the steps to create an LLC, but it could cost you exponentially more if someone decides they want to sue you.
However, if you do decide that an LLC is worth it for you, then be sure to go through the steps above, and spend more time learning about how you can maximize your protection under that LLC to avoid courts piercing the corporate veil and coming after you.