Freelancing and sole proprietorships are often mistaken to be wholly identical, and while they are strikingly similar there are minor differences that need to be observed. In fact, freelancing is actually an ideal profession to be run as a sole proprietorship.
A freelancer is someone who doesn’t work for one company, but rather works on a contract basis with various companies. They are generally seen as being self-employed and there is a great deal of freedom associated with the term as the freelancer has the ability to choose on what to work, whom to work with, and when to do it.
However, a sole proprietorship is an informal business structure where there is no legal separation between the owner and the business. The owner is eligible for all of the profits but also all of the losses and is even liable to lawsuits. A freelancer is actually a prime candidate for a sole proprietorship alongside others such as counsellors, independent contractors, artists, musicians and tutors.
What are the characteristics of these professions?
All of these professions have the characteristic of low-profit and low-risk when it comes to forming a business, and as such they have a decreased risk of liability or financial ruin. Their customer base is also limited, and generally confined to those they know personally such as friends, family, or neighbors. They often originate from the owner’s hobbies which become sources of income.
How do you operate as a sole proprietorship?
A lack of distinction between owner and business means that the owner signs legal documentation such as checks, contracts, and lease agreements in their own name. Payments are also made out to the owner’s personal name. However, should the owner wish to conduct business under a different name then filing for a DBA (doing business as) is required. This allows the business to open a business bank account and accept payment from clients under a fabricated name.
Do you have to pay to start a sole proprietorship?
This is one of the primary benefits of a sole proprietorship as it requires no startup funds. However, as a sole proprietorship is not a legally separate entity to the business, the business income is incorporated into the owner’s personal tax return. Furthermore, as you will essentially be self-employed, you’ll be liable to pay both income tax and self-employment tax annually.
What are the risks in forming a sole proprietorship?
There are four substantial risks when establishing a sole proprietorship:
1. Zero personal liability protection.
This means that your personal assets are fair game in the event of your business’ financial ruin or lawsuits filed against the business.
2. No tax advantages.
Sole proprietors have to pay taxes based on their profits and they also have the responsibility to pay FICA taxes (Medicaid and Social Security taxes). The moment that the business starts making some real money, the taxes will be costly.
3. Reduced possibility for expansion.
As a business makes more money, the risk involved becomes exponentially bigger. When this happens, a formal business structure becomes more necessary.
4. Less reliability and branding potential.
All legal and banking transactions of a sole proprietorship are done in the personal name of the owner, unless they have filed for a DBA. However, this does not always inspire trust in clients and often makes a business appear less credible.
Is it difficult to form a sole proprietorship?
What is most significant about a sole proprietorship is that generally there are no flings or fees necessary in order to create a sole proprietorship. In fact, there are many people who are actually sole proprietors without knowing it. The moment that you start conducting business in your own name, you essentially become a sole proprietor.
If you want to find out more, TRUiC offers substantial information on the features of a sole proprietorship and whether it is the right business structure for you.