Consulting Business Basics for the Solo Service Professional

Considering starting a solo professional practice or freelancing?  Whether you have been contemplating the leap to self-employment for a while or have started considering freelancing due to underemployment, there are some essentials you need to start.  This post reviews the basics of business structure, bookkeeping and taxation.    

Sole proprietorship versus Single-Member Limited Liability Company (LLC)

For the freelancer, the simplest structure is a sole proprietorship.  This type of structure is essentially the individual.  There is no business registration or licensing with your state authorities; you still need to comply with any applicable local business license, registration, or permit laws.  Your business is operated by you as an individual and you are personally responsible for all liabilities.  Creditors can pursue your personal assets for any of the sole proprietorship liabilities.  To mitigate risk, you should obtain general business liability insurance and appropriate professional liability insurance for your field.  If you wanted to operate under any name besides you own, you would need to register your “Doing business as” with the appropriate government office in your state; however, if you are that committed to your consulting business, you should really consider becoming a single member LLC (Limited Liability Company).

A limited liability company does require filing formation documents with state authorities and paying filing fees.  The single member LLC is a separate business entity from its owner, having its own name and employer identification number.  Generally, the member is not personally responsible for the liabilities of the LLC; some exceptions exist, including LLC debt personally guaranteed by the member or intentional fraud or illegal acts committed by the member.  States typically require LLCs to complete annual report filings and pay annual fees.  The fees and filings required for the LLC structure are the only drawbacks compared to the sole proprietorship.  Additionally, some marketers think that the LLC suggests more permanence and stability to the freelancer.  Many professionals use services or lawyers for LLC formation and annual filings while others may choose the do-it-yourself route.

Bookkeeping

Regardless of your solo practice structure, good record keeping is essential.  Keep your permanent records, invoices and receipts organized.  Ideally, you should segregate your business income and expenses from your personal expenses in separate bank and credit card accounts.  The LLC must open its own bank account; comingling LLC and personal activity in combined accounts can jeopardize the treatment of the LLC as a separate entity.  Operate your business as a separate entity regardless of your legal structure so that you can have clean business records for yourself and for your income tax returns. 

If you are just starting out with limited activity, you can track your income and expenses in a spreadsheet.  Once you commit to an ongoing business and your revenues and expenses are growing, you should use actual accounting software to track your business accounts.  There are several options available; cloud-based software as a service typically costs a monthly fee but provides easy linking to bank and credit card accounts, accessibility from multiple devices anywhere with internet service, and data back-up.  QuickBooks Online is the most widely used but Sage 50cloud,  Zero and Freshbooks are alternatives.  Many software packages are aimed at small businesses and the self-employed, but this does not mean they are failsafe.  As your business grows and you contemplate using a software package, you can really benefit from consulting a bookkeeper or accountant.  Having your general ledger organized properly with relevant accounts and some initial training can greatly simplify the process.

Typically, most solo professionals track income in one account.  Expenses should be consistently classified in accounts to help you manage your business and file your income taxes.  Some standard expense accounts include advertising, dues and subscriptions, insurance, legal and professional fees, office expenses, rent expenses, supplies, licenses and permits, travel, meals and utilities.  If there are specific expense categories you want to manage for your business, you should use them.

Taxation

For tax purposes, a single-member LLC is a disregarded entity, which means it is treated identically to the sole proprietorship.  The sole proprietorship is taxed at the individual level; you will complete a Schedule C Profit or Loss from a Business as part of your 1040 U.S. Individual Income Tax return. 

The newly self-employed freelancer usually knows that she will pay income taxes on any net income generated by her business.  What often surprises people is that self-employment taxes are also due.  The self-employed are responsible for both the employee and employer portions of Social Security and Medicare taxes, totaling 15.3% of self-employment income in 2020.  You will complete a Schedule SE Self-Employment Tax in addition to the Schedule C.

Certain business expenses require additional support beyond the receipts for tax authorities.  For any business trips or business meals, in addition to the receipt you should document the business purpose of the travel or meal.  For meals, document any other attendees and their business relationships as well as the purpose.  Mileage for business trips can be deducted at the current IRS rates; many people use apps to easily track business trips and mileage such as MileIQ or Milebug.

Some dues and memberships may not be fully tax deductible.  You may be able to deduct expenses for a home office.  Self-employment requires additional knowledge around tax schedules and tax rules.  Additionally, quarterly estimated tax payments are required for the self-employed or else federal and state governments impose underpayment penalties and interest.  Given these complexities, many professionals benefit from having a tax preparer to help with tax planning, estimated tax payments and tax filings.

Summary

Beginning a solo practice can be challenging and exciting.  Consider your long-term goals and your risk tolerance when determining your business structure.  Keep good records business records, tracking your income and expenses regularly.  Plan on taxes becoming more complex.  Even though you are freelancing, you can still have your own team; when needed, seek out professional advice to help you maximize your success.