Jack DonaldNot all aspects of running a freelance business are fun. In fact, some are downright boring. Take registering your business for example. It’s tedious, confusing and it can be time-consuming.
But, that doesn’t mean it’s any less important.
Here’s the thing about registering your business…
The type of company you set up affects almost every area of your business including taxes, finances, operations and liabilities.
So, this week I decided to shed some light on this and help you decide what legal business entity would be best for you.
Part 1: Business Permits and Licenses
Practically every business needs some kind of a license or permit to operate legally – freelancers are no different.
Some of them are fairly obvious like alcohol or tobacco. It’s common knowledge that you need a proper license to sell them. The same goes for commercial fishing, radio broadcasting and many others.
But even if you offer marketing consulting or design services, you still might need to obtain various permits before you can legally conduct your business and sell your services.
Take my company, Business Sustem as an example. I live in Austin, Texas and since I run my business from a home office, I’m required to have a home occupancy permit.
The same is true for Freelancers in the US. Those who work from home, often need a home occupancy permit as well as a general business license.
Contrast this with most European countries, where you can operate most home businesses without the need for a home occupancy permit of any kind.
Here’s my point…
It’s important to research the licenses and permits you require before registering your business.
Failing to do so may result in grave consequences.
Take for example Liz Swain…
A few years ago, Liz received a $302 bill for operating her freelance writing business without a license. Not only was she charged for the initial registration fees but she also received hefty late payment fees, as well.
In short, it was a mess and a brutal way for her to spend the labor day weekend. You can read her story here.
To play it safe, research the licenses you may need to operate in your area.
Where to Find this Information?
For one, check out information provided by your local government.
If you live in the US, visit the US Small Business Administration State Licenses & Permits site.
And if you’re in the UK, use the License Finder Tool.
To ensure you’ve crossed your t’s and dotted your i’s, conduct a separate Google search to see that you haven’t missed anything. Use such search phrases as:
- Business Registration + Your City
- Business Permits + Your City
- [Your profession] + Business Permits + Your City
- [Your profession] + Business Registration + Your City
These should reveal articles and information from other sources than just your government discussing licenses you might need to obtain and offer tips to ease the process.
Part 2: Legal Business Entities
When registering a business, you must decide what legal entity you’re going to establish. This will help determine what sort of tax form you’d have to file, how you’re going to deal with finances and what liabilities you’re going to have.
The 4 most common business entities are:
- Sole proprietorship,
- Partnership,
- Limited Liability Company, and
- Corporation
Let’s explore each of them in more detail.
Sole Proprietorship
This is by far the most common business entity among freelancers.
A sole proprietorship, also known as sole trader is simply a business run and operated by one person and in which there is no legal distinction between the owner and the business.
The lack of legal distinction means that you and the business are in fact one. You are responsible for all business elements and are personally accountable for its finances and liabilities.
All the business assets and the money you earn are yours (bar any tax obligations of course). But you are also responsible for any business debts and loans too. This means that if your company owes money, your creditors will be able to reach your personal possessions (i.e. car, house, laptop etc.).
In most countries you are not allowed to hire employees as a sole trader. However, in the US, the IRS allows a spouse of a sole trader to work for the business. He or she, however is not classified as a partner or an independent contractor and thus the business can retain its sole proprietorship status and not be required to submit a partnership income tax return.
In some EU countries, you can employ people providing that you register your sole proprietorship for the appropriate taxes.
Lastly, if you are a sole proprietor, you pay personal income tax on all revenue generated by your business.
To find out more about sole proprietorship in your region check out these sites:
- Canada: https://www.canada.ca/en/revenue-agency/cra-canada.html
- US: https://www.sba.gov/business-guide/launch-your-business/register-your-business
- UK: https://www.gov.uk/set-up-sole-trader/overview
Partnership
Partnerships are less common among freelancers unless the intention is to run and market the business as an agency or studio.
US Small Business Administration defines partnership as a single business where two or more people share its ownership and each partner contributes to all aspects of the business, from money to labor and skill.
In return, each partner shares profits but also losses of the business.
There are 2 types of partnerships you could incorporate:
- General partnerships in which all responsibilities, liabilities and profits are divided equally among partners. Some partnerships have an unequal distribution of shares between partners which have to be documented in the partnership agreement.
- Limited partnerships (or partnerships with limited liability) allow partners to have limited liability and limited contribution to the company’s operations and are based on the percentage of each partner’s initial investment in the business.
- Lastly, if you plan to work with someone on a single project only, you could also set up a Joint Venture, a general partnership that exists for a specific purpose and for a limited time.
Limited Liability Company (LLC)
A limited liability company is a form of private limited company specific to US.
- If you’re living in the EU, instead of LLC you’d be setting up a Private Company Limited by Shares (Ltd.).
- In Australia you’d be registering a Pty Ltd (proprietary limited company).
- In Canada, you’d be limited to a Corporation.
Here’s a full breakdown of private limited companies across many countries.
The important to remember about private limited companies is that:
- They are not corporations. LLC combines certain characteristics of a corporation but also partnership and sole tradership (depending on how many owners there are), and
- They provide a limited liability to its owners. But the extent of those limitations is different between jurisdictions.
Just like sole traders and partners in a partnership, owners of LLC companies declare business profits or losses on their personal income tax returns, meaning that the LLC itself is not a separate taxable entity.
But just like owners of corporations, LLC owners are protected from personal liability for any business debts, loans and claims (that’s exactly what the limited liability means, by the way).
If a LLC company owes money, only the business assets are at risk of repossession. Again, some countries allow creditors to reach LLC owners’ personal assets (i.e. house or a car). However, in general, LLC is responsible for its losses or debts with its possessions.
Corporation
A corporation is admittedly the least likely business type you will register as a freelancer – especially when you’re first getting started.
Having said that, your business might grow to a point where forming a corporation is viable. So, let’s cover what it is very quickly.
A corporation is a separate legal entity. It can enter into contracts and own property in its name, separately from its owners.
Corporations are owned by shareholders whose liability is limited to their investment. They typically do not manage a corporation, instead elect or appoint a board of directors to control it.
What’s interesting is that in spite of (obviously) not being human beings, by law they are legal persona and have many of the same rights as people do. They, for instance can exercise human rights against the state (and can be responsible for human rights violations too).
Corporations are typically suitable for businesses earning in excess of $100,000 per year. This is due to the taxation on earnings and dividends. However, in registering a corporation you also accrue additional accounting fees, and the dreaded double taxation that occurs when a dividend is received.
In short, you’re more likely to start with a sole proprietorship, partnership or LLC than a corporation.
Part 3: Registering Goods and Services Sales taxes
In many jurisdictions you will have to register your business for the value added tax.
If you’re operating in Canada, for instance, you’ll have to collect and file GST/HST once your revenues hit $30,000 or more. The Goods and Services Tax (GST) applies to most goods and services, including intellectual property and other intangible personal property.
In provinces that have harmonized their provincial sales tax with GST you will have to file HST (Harmonized Sales Tax). These provinces include New Brunswick, Nova Scotia, Newfoundland and Labrador, Ontario and Prince Edward Island.
If you live in Canada, check this page for the current GST/HST rates.
In the US, 45 states require you to collect sales tax, which I agree, can be quite confusing. In Alaska, Delaware, Montana, New Hampshire, and Oregon you aren’t required to collect sales tax.
For one, sales tax and rates vary from state to state (and get tricky if you sell to customers in more than one state). In order to collect sales tax you will have to obtain a sales tax permit. US Small Business Administration website features a great resource on sales tax in the US.
In many European Union countries you have to collect VAT (the value added tax) for goods and services once your revenue exceeds certain amount. In Ireland for instance you are required to register for VAT if you generate (or expect to generate) turnover from services to the value of €37,500 or more in any given 12-month period.
Part 4: Bringing It All Together – Registering Your Business
You’re still with me? Great, it proves you’re really determined to launch your business!
And I know, there are many intricacies in the process but believe me, once you’re past that stage you’ll likely never have to review it again.
So, let’s go through the process of registering your business once again to make sure you know what to do (and then I’ll leave you to go through the process):
Start by researching what licenses and permits you need to operate.
Unfortunately, you will need them to operate. Depending on where you live you might need a general business license (and remember that you will have to obtain another one if you move to a new location). And if you plan on working from home, you might need a Home Occupancy Permit.
So, task #1 is to check with your local authorities as to what permits you’re required to obtain.
Then choose a legal entity for your business.
When registering a business, you must decide what legal entity you’re going to set up: sole proprietorship, a partnership, a limited liability company or a corporation.
Your #2 task therefore is to research and decide on the legal entity for your business.
Hint: If you’re unsure which one would be best for you, talk to your accountant. They should be able to point you in the right direction.
Lastly, register Goods and Services Sales Tax
In most countries you are required to collect and file sales tax. In Canada, it’s GST/HST, sales tax in the US and VAT in Europe. And many regions, states and countries will have different requirements for it so task #3: research your sales tax obligations.
And then… fill in whatever paperwork that’s required and register your business.
