The freedom to control the process and method when working for another makes freelancing an enticing way to earn income. Those that choose this arrangement over conventional employment have some flexibility in determining how to structure their business, how to be paid, and how to handle profits and losses for income tax purposes.
Overview of Freelancing
A freelancer, also known as an independent contractor, is an individual who performs work for another while retaining control over the process and methods for completion of the project. The employer has limited control over the independent contractor beyond what is mutually agreed upon.
Overview of a Sole Proprietorship
A sole proprietorship is a type of business structure that is owned by a single individual. No formalities are required and the business is created the moment the individual starts operating. As such, the company and the owner are considered as one; therefore, any liabilities of the business become the liabilities of the owner. The same rationale is true for profits, with the owner retaining complete control over the management and operations of the business. Over time, sole proprietors can hire employees to handle work demand or engage the services of independent contractors, or some combination of both.
Read More: Tax Differences Between an LLC & a Sole Proprietorship
Business Structure Options
A person engaging in work as a freelancer has a few options on how to operate, including remaining a sole proprietor or creating a business entity separate from the owner. Limited liability companies (LLCs) and corporations are two examples of separate business entities that effectively remove the owner from personal liability for most debts and legal obligations incurred by the business. Although it varies from state to state, formation of either of these business structures generally requires the selection of a business name and the filing of articles of incorporation with the state.
Because a sole proprietor and the business are one, the owner must report any income earned on his personal tax return and pay self-employment taxes. However, the business is not required to file a separate return or pay additional taxes. If an independent contractor decides to form an LLC, the owner can elect to treat the company as a sole proprietorship or a corporation for tax purposes. A corporation is a separate tax-paying entity and is typically required to obtain a federal tax ID number. It is also subject to double taxation, meaning that taxes must be paid on income earned by the business and then again for any dividends paid out.
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