If you’re a full-time freelancer, you can enjoy great freedom which many others don’t have. With this, though, comes a big responsibility: you have got to pay great care and attention to your finances and cash flow.
Freelancing’s popularity is at an all-time high, as more and more people want to ditch a 9 to 5 routine and earn their own money.
The freelancer market has seen rapid growth which was unforeseeable just a few decades ago, thanks in part to the kids of the digital age growing up and seeking a flexible work schedule, which allows them to live the life they want.
A freelance income can be unpredictable, so it is very important to properly manage your money, which is not as difficult as you might think it is.
1. Create a Sensible Budget
To some people, budgeting is a dirty word. Sure, if you’re earning a big paycheck, budgeting probably isn’t at the front of your mind.
Whilst freelancing can earn you a comfortable income, budgeting is still important, and it is not as daunting as you may think.
There are lots of different budgeting methods, techniques, and guides available on the internet to help you out.
I think that the 50/30/20 method is a great place to start your budgeting and get a basic one down on paper. This method puts 50% of your after-tax income (more on that later) towards necessities, 30% for non-essential purchases, and 20% for savings.
2. Get Ahead of Taxes
Just because you’re freelancing and earning your own money does not make you immune from taxes. It is very important to get ahead of your taxes, so you don’t get a nasty surprise at the end of the tax year.
Whilst an employer would be responsible for your taxes and it would all be done automatically through payroll, this is not the case when you are your employer.
Each time a client pays you, work out exactly how much of that payment needs to go towards your taxes and set it aside in a separate account. That way, when you get your tax bill, you’ll have the exact amount set aside ready to pay to the government.
3. Registering as a Freelancer
Being a freelancer isn’t all fun, games, and freedom. Some things are just plain boring; registering yourself as a freelancer or registering a business is no exception to this. It can be quite confusing and tedious, but it is something that you are legally obliged to do.
How you are registered does matter, because there are entirely different legal and tax implications depending on whether you’re a registered business or a sole trader.
1. Sole Proprietorship
This is the most common way for freelancers to register their business interests. A sole proprietorship (or sole trader) is a business owned and operated by one individual where there is no legal distinction between the owner and the business.
As a sole proprietor, you are entirely responsible for your business and are accountable personally for its finances and liabilities, and all business assets are yours.
Although this is unlikely something which you need to worry about as a freelancer, any business debts or loans are also your responsibility, and creditors can take control of your possessions to discharge business-related debts.
The most important aspect of being a sole proprietor and handle your finances is the tax implications. As one, you pay personal income tax on all the money you earn as a freelancer. If you freelance on the side of a full-time job, this could push you into a higher tax bracket.
2. Limited Liability Companies
Much like its name suggests, a Limited Liability Company (LLC) limits the liability of its directors, but the extent of these limitations differs between states and jurisdictions.
LLCs have a combination of characteristics from both corporations and sole proprietorships and, just like sole proprietorships, the directors of LLC companies declare their profits and losses on personal tax returns, which means that, although a separate legal entity, an LLC itself is not a separate taxable entity, you can apply to be treated as a corporation for tax purposes.
However, LLC owners are protected from personal liability for business debts (hence the name limited liability) which means that creditors cannot chase your assets to discharge the debt. This is unlikely to be an issue for most freelancers, but it is worth mentioning.
Although this is an unlikely business type for a small-scale freelancer to handle their finances, it is viable if your freelancing is beginning to scale up and grow. Corporations are separate legal entities – they are their legal person – separate from its owners, and the corporation can form contracts in its name.
Corporations are owned by shareholders whose liability is limited to the value of their investment.
4. How to Form a Company
Registering as a Limited Liability Company is a way to handle your finances if you’re a freelancer looking to register your interests and is the best route to take.
Although for tax purposes, it is no different from being a sole proprietorship, you have the added legal protections of not being personally liable for business debts, which can become a real possibility as you scale your freelancing business.
An LLC can choose to be treated as a corporation for tax purposes by the IRS by filing form 8832.
Whether or not this is the right solution for you depends on your circumstances and the nature of your freelancing business (e.g. are you a full-time freelancer or does it supplement your income? Do you earn so much that you might benefit from the different tax rates for corporations?)
You may be wondering how to form a company; it’s quite simple. There are plenty of resources on the internet that can help, and it is as easy as selecting a state to register in, choosing a name and Registered Agent, and then filing your Articles of Organization.
Although there is a bit of paperwork involved, registering as an LLC is the best option for freelancers to handle their finances, particularly if you are going full-time or have long-term ambitions.