The further you get into your freelance career, the more choices you’ll be faced with, whether it comes to potential clients you submit proposal templates to, or other aspects. Among the most talked about is how to structure your business. Do you choose to keep your tax status as a single business owner under a sole proprietorship? Or do you put in a little extra work to form a limited liability corporation (LLC)?
Both are valid ways to run your business, and come with all the perks of being self-employed (such as claiming expenses like the home office deduction), but each has unique benefits -- and a few disadvantages.) Since not all freelancers agree on the right way, it’s wise to know everything you can about each. Read on to see which situation will be best for you!
How you conduct your business on a day-to-day basis will likely not look much different between the two types of entities. A sole proprietorship, however, most closely resembles a personal tax set up. In fact, the popular method of filing was embraced by over 23 million tax filers in 2010, with 75% of those reporting a profit on their earnings.
To take advantage of the sole proprietorship status, you’ll report your income from your business on a schedule C form on your personal tax return and then transfer that amount over to a 1040 or 1040 EZ. You don’t most likely won’t need to file any special paperwork or register to be a business entity for tax purposes. It will look and feel very much like when you report income from a typical job.
(Note that you may have some extra considerations regarding taxes, however. You’ll be subject to the self-employment tax, for example, and will want to carefully track your income and expenses – just like any business.)
Because your income is tied to you as a person, you won’t have any special protections that a formalized business might have. Any liability against your business will be held against you, as well. If you get sued for creating content that is considered defamatory, or your services cause a client to suffer losses, you will have no way to separate your personal wealth and assets from your business. In short, claims can be made against everything you have and own to satisfy your business debts.
A limited liability corporation, however, is a true, blue corporation. Most freelancers that choose to “incorporate” (the fancy term for forming a corporation) do so as a single member LLC. They are still solo entrepreneurs, but they have the legal advantages of a corporation. Your personal assets are kept separate in the event that anyone ever goes after your business for damages or debt. It’s an extra step that many feel is necessary to ensure personal prosperity.
There is also a tax benefit for many who incorporate as a single member LLC. Like the sole proprietor, your income is considered “pass through income, and you won’t get double-taxed for both personal and business income.
In exchange for the protection you get from being a corporation, however, there is some red tape to cut through. For one, you have to form and register your corporation with the appropriate agency in your state. Most likely, the Secretary of State’s office can point you in the right direction.
This process isn’t free. In addition to drafting and filing the articles of incorporation (which will cost money if you hire someone to help you), there is the actual filing fee. This ranges from $50 to $500, depending on your state. Then, there is the annual fee to keep your corporate status. A few states don’t charge this, but some require you to report the status of your corporation – along with paying the fee – every one or two years. This can range from $15 to over $250, as well.
While no one can make your tough decisions for you, there are some basic guidelines to help you determine if you’re better of as a sole proprietor or an LLC. For one, if you’re not sure that you’ll take your freelance business from hobby status to business status (earning more than $400 this year), or plan to start a creative agency, it doesn’t make much sense to spend a lot up front to incorporate. Some people just can’t afford the initial cost to start a corporation, and that’s OK.
Additionally, many people like the straight-forward nature of paying taxes as a sole proprietor. If you do your own taxes, and like the ease of filing a schedule C on a form 1040, you’ll enjoy the quick work that most tax software services make of sole proprietor tax issues. It’s also much more affordable to file this way than to file as a corporation – which may require the help of a tax professional or CPA.
However, no one can dispute that incorporation has its perks, as well. If you foresee making a good living as a freelancer this year, there is no substitution for the protections that incorporation offers. Working in the public eye can leave you open to liability, so it’s wise to look into how an LLC can protect your assets – especially if you have a lot to lose by not doing so. If you live in a state where filing articles of incorporation is affordable, it might be the best option for you.
Fortunately, you aren’t locked into any decision forever. Admittedly, it’s much easier to go from a sole proprietor to an LLC, as this is how most people go about it. If you get into your business and feel like your success warrants the extra protections of an LLC, you can choose to file at any time. You don’t have to wait for a certain time of year or for your business to reach a certain level of success to do so.
Switching from an LLC to a sole proprietorship, however, takes a bit more work. To do this, you’ll need to file articles of dissolution with the state agency that originally filed your incorporation paper with. You’ll also need to notify any creditors of your decision. (This may require you paying off debt in the name of your LLC to clear up all your accounts. You can always set up new accounts under your own name as a sole proprietor.) Finally, you may need to announce your dissolution in your local paper, depending on your state requirements.
Once you’ve dissolved your LLC, it’s possible to pick back up where you left off – only using your own name or your DBA as a sole proprietor. You’ll want to make sure that all of your branding reflects the change, from your website, to your checks, to your invoices.
Most freelancers need a little time to figure out the best structure for them, and that’s OK. Actually, it’s best to work through exactly how much you’ll be working, what your earnings might be, and how much liability you’ll really face with your new business. If you’re starting your business toward the end of a tax year, it might not make sense to pay out too much for an LLC in a more expensive state, since it will cut into your earnings. Many choose to do this at the beginning of a year in which they expect to be profitable (making much more than the required $400 in profits to file.)
Like all tax and finance matters, it’s best to address any questions you have by reaching out to a seasoned professional in your area. Find a tax pro that is used to the unique needs of freelancers. It’s better to be safe than sorry, especially when the penalty for not setting up your business correctly could be extra taxes, fines, or worse. Experienced freelancers agree that taking the time to do it right is something you’ll never regret!
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A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?