From Freelancer to Entrepreneur: When to Transition to a Formal Business Entity

fusion-cpa-transitioning-from-freelancer-to-entrepreneur

The journey from freelancing to entrepreneurship can be as exhilarating as it is challenging. After all, it’s so much more than just a change in title. It involves embracing a new mindset, expanding your vision, structuring your operations, and mitigating different risks and challenges. 

In this blog, we’ll help you navigate the transition from freelancer to entrepreneur. We’ll cover all the crucial aspects of this change, from the differences between the two, to how to choose the right business entity. 

 

Freelancing vs. Entrepreneurship

To start with, let’s talk about how a freelancer is different from an entrepreneur. Freelancers usually work independently for various clients, on a project-by-project basis. On the other hand, entrepreneurs run a formally structured business entity, most often with the aim to scale it. As such, they may require a team of workers, and sufficient resources to do this. 

The two roles differ with regards to the level of responsibility and financial management you have over the work you do, as well as the scale of your operations. 

While some full-time freelancers are happy to pick their clients and work when they need or want to, this isn’t ideal for everyone. Despite the benefits of freelancing, the downsides can include a lack of predictable income, and challenges growing your operations. 

So what do you do if you’d like to hang up your freelancer hat and start your own business? The most important step in this transition is to create a formal business structure.

But how do you know if it’s the right time to do so?

 

Signs It’s Time to Formalize Your Business

There are several good reasons to make the transition from freelancer to entrepreneur. For example, you may be unable to keep up with your current workload. If you’re consistently handling more work than you can manage alone, and have to turn down projects, it might be time to consider expanding into a formal business. This is especially true if you start receiving larger or more complex projects that may require collaboration. After all, the more work you get, the greater your admin burden, and sometimes it’s just not viable to handle everything on your own.

Or perhaps you want to scale. If you’re often hiring subcontractors to help you out, it may be time to formalize your business. 

And then there’s the issue of liability. As a freelancer, your personal assets might be at risk if you face any legal issues. However, when you form a business entity, like an SMLLC or corporation, these feature liability protection to safeguard your personal assets. Having a formal business can also make getting insurance and risk management much easier. 

Despite this, taking the leap from freelancer to entrepreneur can be challenging, and isn’t exactly risk-free. So you need to be sure you’re truly ready to make the change. This includes:

  • Having the right skills and experience. Starting a company means you need more than just the necessary technical skills for projects. You’ll also need to be able to handle business operations, manage teams, and undertake strategic planning. Consulting a business advisor or mentor can help you gain the right skills. 
  • Make sure you’re ready financially. Businesses need financing, whether this comes from your savings, or loans and credit. You must have enough capital to cover initial expenses, like registration fees, and employee salaries. A detailed budget and financial plan can help with this. 
  • Having the time to commit. Dedicating your working hours to projects is one thing, but when starting a business, you need to have enough time available to handle all the responsibilities. This may mean longer hours and overtime until your business is on its feet. 

The benefits of making the transition

Having a formal business is a great way to establish credibility, create brand awareness, grow, and upskill yourself. But it can also have a significant impact on your taxes. Once you incorporate, you aren’t taxed the same way as an individual employee, and you have access to tax breaks in the form of credits and deductions that can improve your bottom line, and grow your business. 

Fusion-CPA-freelancer-to-entrepreneur-tax-credits

At the same time, because there’s a separation between individuals and some business entities according to the IRS, you can significantly reduce the liability risks mentioned above, for added peace of mind. 

A formal business structure can also help you access to credit or funding. After all, banks don’t lend to unregistered businesses. Also, there are several government programs that offer grants to help improve your liquidity and scale. 

 

Understanding Different Business Entities

The first step in transitioning from freelancer to entrepreneur is choosing the right business entity for your needs. And there are several options to choose from. 

Single Member Limited Liability Company (SMLLC)

SMLLCs are one of the most common types of new businesses in the US. They are considered disregarded entities for federal tax purposes, meaning that income is reported on your personal tax return, via Schedule C.

An SMLLC is generally required to make quarterly estimated tax payments. These cover your income and other taxes, such as self-employment and alternative minimum taxes.

Partnerships 

This is a formal business arrangement between two or more parties to jointly manage a business, and share profits and liabilities. 

A general partnership is a business started with at least one other person, without incorporating (or legally separating yourself from your business). It is easy to start, as it does not require filing any paperwork with your state. It is also not held to certain compliance activities, such as recording meeting minutes. They also offer flexibility when drafting partnership agreements. 

Limited partnerships have a general partner and at least one limited partner (sometimes called a passive partner). A passive partner has no managerial authority but is usually a financial backer who participates in the profits. However, these profits can be subjected to self-employment taxes. 

C Corporations

A C corporation or C Corp (named for being in subchapter ‘C’ of the Internal Revenue code) is a legal structure for a business entity that is separate from its owners or shareholders. C Corps offers limited liability protection and has a flexible ownership structure, allowing for an unlimited number of shareholders. 

Transferring or dividing ownership between shareholders is done through stock. On the downside, the entity is subject to double taxation; a 21% flat tax rate at the corporate level, and shareholders are taxed on any money taken from the business (usually as dividends). 

S Corporations

The S corporation or S Corp (named for being subchapter ‘S’ of the Internal Revenue Code) is ideal for those who don’t want to go public or attract institutional investors. 

S Corps has a capped number of shareholders. These can be individuals, estates, and certain types of tax-exempt entities or trusts, as long as they are US citizens or permanent US residents. Additionally, they have only one class of stock and one level of taxation. 

 

Steps to Transitioning

If you’re ready to make the change from freelancer to entrepreneur, you will already have an idea of your target market and industry gaps – after all, your business will be catering to these. But there are other important aspects to consider.  

A business plan 

You’ll need a detailed business plan. This outlines your business goals, objectives, and overall vision. It also lets you make strategic decisions for financial planning, attracting investors, and pinpointing your company’s strengths and weaknesses. 

It contains information about your products or services, marketing strategies, and finances. This includes:

  • A description of your business and its products or services
  • Your goals and objectives
  • A marketing plan
  • A financial plan and cash flow projection
  • Information about your management team
  • Details about your competition
  • Risk factors involved in your business

In a nutshell, it includes detailed information that can help improve your company’s chances of success. 

Choosing and registering the right business structure

Once you know which entity structure is right for you, you need to get started on the paperwork for forming SMLLCs and partnerships, a C Corp, or an S Corp

No matter what entity you choose, it’s important to be aware of the reporting and compliance measures associated with each. This includes:

Fusion-CPA-can-help-with-business-structure-freelancer-to-entrepreneur

A tax professional can help you navigate these legalities with ease. 

Financial planning and budgeting

Your budget is a road map for financial planning, allowing you to allocate resources, manage cash flow, and make good decisions. 

All good budgets start with cost identification. Of crucial importance are the essential startup costs you incur before you launch your business. These include assets like equipment, inventory property, or vehicles. These are considered capital expenditures, and they aren’t tax deductible. On the other hand, startup expenses including rent and payroll, are tax deductible. 

You’ll also need to consider your ongoing operational expenses and income taxes. Knowing what you’ll be giving out each month will help you create a realistic budget. It will help you respond to different business cycles. 

Remember to budget for the unexpected; like an emergency fund that can act as a buffer for expenses like repairs or legal fees. 

 

Legal and Tax Considerations

Transitioning from a freelancer to an entrepreneur involves several legal and tax considerations. 

For example, you need to ensure you have a registered business name and EIN (Employer Identification Number) from the IRS for tax purposes, as well as any state and local licenses. 

Depending on the entity you choose, you may also need to establish operating agreements or corporate bylaws, which outline your management structure and operating procedures. Your state may also require you to file annual reports or keep meeting minutes. 

All of this requires accurate and detailed records of all financial transactions. However, with the right accounting software, this is easy to manage. Alternatively, you can outsource your accounting to keep your focus on your core business. 

Importantly, you also need to understand all the tax reporting requirements, tax laws and tax deadlines to ensure your business remains compliant with the IRS. 

Tax pros like the team at Fusion CPA can help you with this and so much more. Our subscription-based tax services ensure that you have a great strategy in place, to make tax season stress-free. 

If you need help transitioning from freelancer to entrepreneur, or with any tax compliance issues, schedule a Discovery Call with one of our CPAs. 

Schedule a Discovery Call


The information presented in this blog article is provided for informational purposes only. The information does not constitute legal, accounting, tax advice, or other professional services. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability of the information contained herein. Use the information at your own risk. We disclaim all liability for any actions taken or not taken based on the contents of this blog. The use or interpretation of this information is solely at your discretion. For full guidance, consult with qualified professionals in the relevant fields.

Menu