Differences Between Sole Proprietorship & Freelance

By Wayne Thomas

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.

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.

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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.

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.

Tax Differences

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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Is It Difficult to Discontinue a Sole Proprietorship?

References

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Can More Than One Business Be Conducted Under One LLC?

A limited liability company, or LLC, is a common and flexible legal structure that is formed under state law. Like a corporation, the owners of an LLC are not personally liable for the debts of the business. Unlike corporations, however, LLCs do not pay corporate income tax and don't have shareholders or a board of directors. Owners of an LLC have the option to set up the business in any way that suits their purpose, which includes the option to create subsidiary companies under the LLC.

Differences Between Sole Proprietorship, Partnership, & Corporation

Business owners have several options from which to choose when selecting a structure for their business. A sole proprietorship is an unincorporated entity that does not exist apart from its sole owner . A partnership is two or more people agreeing to operate a business for profit. A corporation is a legal entity -- a "person" in the eyes of the law -- existing separate and apart from its owners. Ease of formation, management, protection from personal liability and taxation are some factors business owners should consider in choosing a business structure.

Can Sole Proprietorships Have Multiple Owners?

When forming a new business, it is important to determine which business structure is appropriate. You should consider the number of owners, and also your potential personal liability for the business. While a sole proprietorship is one of the easiest structure to form and operate, it is not appropriate for every business. If you want to have more than one owner, a partnership may be more appropriate.

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