October 15, 2016
This is a compendium of my answers to common questions about setting up a business as an independent consultant or freelancer. Many of these are simply the best and most straightforward answer. They come from several years of running a consulting partnership and somehow managing not to sink it.
These are questions that are largely necessary but hardly sufficient to running a good business. People like to get caught up in these anyhow, so if you’re spinning your wheels thinking about what to do you could do much worse than following the advice here and focusing your energy instead on things like finding clients and working on those relationships.
Note that some of this - especially tax or corporation related - may apply only or mainly to people operating in the United States and further that I am neither a lawyer nor a CPA.
If you’re running a solo business then the best course of action is to set up a Limited Liability Corporation (LLC). Ensure that everything is owned by the business and that all legal relationships are to the business, not you personally.
That’s the advice. That’s it. What follows is a discussion about the alternatives we’re rejecting and more detailed options for the future.
The alternatives are, one, to operate as a “naked” sole proprietor, that is, running everything in your name, perhaps with a trade name (DBA, or doing business as), or two, create a C corporation.
Here’s some advice I ran across years ago about how to decide between LLC and C corp:
And here’s a mini-rant on the choice of corporate entity and location. For 99% of companies, there is ONLY ONE QUESTION you need to ask when it comes to incorporating: is it likely my business will ever take institutional investment (i.e. a big VC round)? If no, incorporate as an LLC (or an S-Corp) in your own state. If yes, incorporate as a Delaware corporation. End of story. Do not get all creative and find some exotic state to incorporate in. There is no point and you will regret it later. - Kosher Bacon: 5 Things That Don’t Make You An Entrepreneur (and 5 Things That Do)
So that rules out C corps.
I’ve heard about S corporations and B corporations, what about those?
First of all, a B corporation is not a legally recognized distinction. It’s a stamp of approvoal, like a “Fair Trade” label on food, offered by an indepenent organization promoting certain socially conscious business practices.
In practical terms, you probably don’t need to worry about B corporation as an independent consultant.
An S corporation, on the other hand, is a legally recognized term, but importantly, does not define the formation of the corporation. This is is a critical distinction! S corporation is simply a tax filing status, which a corporation may elect - either a C corp or an LLC - that ensures that for tax purposes the corporation is treated as a pass through.
In practical terms this means that as an LLC owner, you can pay yourself a moderate salary and then take the remaining profit as dividends, meaning it is taxed at the dividend tax rate regardless of your upper tax bracket and that it is not subject to FICA tax (for non-US readers FICA includes our Social Security and Medicare taxes).
When should you elect S corp status? Probably not right away. Jason Blumer, a CPA who hosts a podcast about business for “creatives”, recommends 80k as the baseline number for making this change. He has a video explaining how the tax savings work as well. You will need to have your books in good order and work with a CPA to do this. It shouldn’t cost more than a few hundred dollars. You can elect to do this later in the year if your CPA follows the late filing procedures.
Use a paid, professional invoicing service that will let clients pay online. We have used several over the years and have been very happy with Harvest (referral link - gives you and me $10 Harvest credit) but almost any of the services will work.
Beyond this, I wrote an entire post just about billing customers. It’s a tiny bit out of date - Zencash has gone the way of the Tasmanian wolf - but everything else is just as pertinent. In summary:
At a bare minimum set up a checking account in your business’s name. Either get a debit card or open a credit card in your business’s name for office expenditures, subscription services, etc. Use an accounting service or bookkeeping software that uses double-entry bookkeeping.
Let’s talk about bookkeping first. You have basically three options: do it yourself, hire a bookkeeper, or use a “service” that does this for you. I put service in quotes because the only one I’ve seen to date - Bench - still has a person behind the scenes. If you can afford it, hire a bookeeper. It’s not a bad idea to start managing the books yourself - with help if necessary - to make sure you understand how bookkeeping works. If you can do it yourself, go ahead, again, at least to start with.
The software? It all sucks in one way or another.
Nobody got fired for choosing IBM, and you won’t cause any hearburn with a bookkeeper if you’re using QuickBooks.
If you’re solo, you have more options. As a solo business owner you can probably get away with just the basic equity accounts - that is, how you track ownership. In a partnership you need to track multiple equity accounts and this precludes many software packages.
If you’re doing the books yourself, you like doing the books, and you live on the command line, the absolute best accounting software is Ledger or one of its various clones (for personal finance I use hledger, a Ledger compatible program that happens to be written in Haskell). They’re all based on a plain text storage format.
When you start out take as little as possible, and just take draws. Once you have traction it makes sense to file as an S corp (in the US) and take a modest salary.
Our first CPA’s advice when we started out was just that: don’t do a salary, keep it simple and take draws as necessary. He was pretty emphatic about that. There’s no financial benefit to you to pay yourself a W-2 salary if you’re still subject to normal tax rates on the profit, including self employment and FICA.
Killing vampires is cool, but don’t be like Wesley Snipes. Pay your taxes. Make estimated payments each quarter because a single large bill with fines is not fun.
The best way to pay these taxes is by being on payroll and filing as an S corp. You don’t have to think [too much] about making these payments, plus the whole benefit of lower taxes on everything else.
With that out the way…
What follows is risky advice that responsible people should take with a grain of salt. Remember how I said I’m not a CPA?
Especially when we started out, and weren’t on payroll, I erred on the side of caution and underpaid the quarterly estimated payment, keeping the remainder in savings (business or personal). The reason was uncertainty about future cash flow (even if you’ll get a refund because you overpaid that’s cash you don’t have during the year). The result was a higher tax bill in April with a small fine for underpayment. The fine was small enough that it was worth the optionality of having that cash on hand.
Another fine post by Ben Lopatin.
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