Guide to Understanding Business Structures for UX Freelancers
Starting out as a UX freelancer? It’s an exciting, albeit slightly daunting, adventure. You’re likely juggling a ton of ideas — maybe even some nerves — about how to get things rolling.
When choosing the right business structure, there can be a lot to consider. But don’t worry, we’re here to break it all down in a straightforward way.
In this post, we'll explore the most common business entities available to UX freelancers, how these structures impact your work with clients, and the tax implications you should be aware of.
Overview of business structures for UX freelancers
Before diving into the details, let’s get an overview of the common business structures you might consider as a UX freelancer:
- Sole proprietorship
- Limited liability company (LLC)
- Corporation (C-Corp and S-Corp)
- Partnership
- Freelance cooperative
- Professional corporation (PC)
Each of these structures offers different benefits and drawbacks, impacting everything from how you're taxed to how much personal liability you carry. Let’s explore these options in detail.
1. Sole proprietorship
A sole proprietorship is the most straightforward business structure. As a sole proprietor, there’s no legal distinction between you and your business. This structure means all business income and expenses are reported on your personal tax return, using the Schedule C tax form. It's a simple setup and often the first choice for freelancers who are just starting out.
Pros and cons
The main advantage of a sole proprietorship is its simplicity — there’s no need to file special paperwork to set it up, and you have complete control over your business. However, the downside is that there’s no separation between your personal and business assets. If something goes wrong (e.g., a client dispute or a lawsuit), your personal assets could be at risk.
Tax implications
As a sole proprietor, your business income is considered personal income. This method means you’ll pay self-employment taxes, covering both Social Security and Medicare. On the plus side, you can deduct business expenses directly from your income, reducing your overall tax liability.
Impact on client relationships
Operating as a sole proprietor may seem less formal to potential clients, but it’s perfectly acceptable for many freelance projects. Do keep in mind that larger clients might prefer working with businesses that have more formal structures, such as LLCs or corporations, especially if they require more complex contracts or liability protections.
2. Limited liability company (LLC)
An LLC provides a middle ground between simplicity and protection. It separates your personal assets from your business liabilities, offering protection if things go south. As an LLC owner, you’re not personally liable for business debts or legal actions against your business, which can provide peace of mind.
Pros and cons
The major advantage of an LLC is the liability protection it offers. Additionally, LLCs have a flexible tax structure — profits can be taxed as part of your personal income, so you’ll avoid the double taxation that corporations face. However, forming an LLC requires filing with your state and paying an initial setup fee, as well as ongoing compliance and maintenance fees.
Tax implications
LLCs are treated as “pass-through” entities for tax purposes, meaning profits pass through the business and are reported on your personal tax return. Going through an LLC means you get to avoid corporate taxes while still receiving liability protection. You’ll still need to pay self-employment taxes, but you may have more flexibility in how you manage your income and expenses.
Impact on client relationships
Having an LLC can enhance your professionalism in the eyes of clients, particularly for larger projects or when working with corporate clients. It signals that you take your business seriously and are prepared to manage both the creative and business aspects of your work.
3. Corporation (C-Corp and S-Corp)
A corporation is a legal entity separate from its owners, providing the highest level of liability protection. There are two main types of corporations: C-Corps and S-Corps.
C-Corps are subject to corporate taxation, meaning the business itself is taxed on its profits, and then shareholders are taxed again on dividends.
S-Corps, on the other hand, allow profits to pass through to the owners’ personal tax returns, avoiding double taxation.
Pros and cons
Corporations offer the strongest liability protection and can attract investors or facilitate selling your business. However, they come with more complex setup and maintenance requirements, including corporate bylaws, regular board meetings, and detailed record-keeping. C-Corps face double taxation, while S-Corps avoid this but are subject to stricter rules on ownership and profit distribution.
Tax implications
For C-Corps, profits are taxed at the corporate level, and dividends are taxed again at the personal level. S-Corps avoid this double taxation, but owners must pay themselves a “reasonable salary,” which is subject to payroll taxes. Choosing between these structures depends on your long-term business goals and how you plan to grow your freelance business.
Impact on client relationships
Operating as a corporation can significantly boost your credibility with clients, particularly larger firms or those in industries where professionalism and reliability are key. It also positions your business for potential growth, allowing you to take on bigger projects and even hire other freelancers or employees.
4. Partnership
A partnership is a business structure where two or more individuals share ownership. There are different types of partnerships, including general partnerships, where all partners share liability and profits, and limited partnerships, where some partners have limited liability based on their investment in the business.
Pros and cons
Partnerships allow you to pool resources and expertise with another freelancer, potentially expanding your service offerings. However, partnerships come with shared liability — if one partner makes a mistake, both partners could be held accountable. Clear agreements and communication are needed for a successful partnership.
Tax implications
Partnerships are also pass-through entities, meaning profits and losses pass through to the partners’ personal tax returns. Each partner is responsible for paying taxes on their share of the profits, and they can deduct business expenses accordingly.
Impact on client relationships
Partnerships can offer clients a broader range of services, as they benefit from the combined skills of all partners. However, it’s essential to clearly define roles and responsibilities within the partnership to avoid confusion or conflicts, particularly in client interactions.
5. Freelance cooperative
A freelance cooperative is a unique business structure where a group of freelancers comes together to share resources, collaborate on projects, and support each other. It’s a democratic model where each member has a say in how the cooperative is run.
Pros and cons
The cooperative model can be advantageous in industries where collaboration is key, offering a supportive network and shared resources. However, it requires a commitment to collective decision-making and may limit individual control over certain aspects of the business.
Tax implications
Freelance cooperatives are typically treated similarly to partnerships, with income and expenses passed through to the members’ personal tax returns. However, specific tax treatment can vary depending on how the cooperative is structured and the jurisdiction in which it operates.
Impact on client relationships
Clients may appreciate the collaborative nature of a cooperative, particularly if they need comprehensive solutions that require multiple skill sets. However, it’s important to communicate clearly about who is responsible for what, to ensure the client knows who to contact for different aspects of the project.
6. Professional corporation (PC)
A professional corporation (PC) is similar to a standard corporation but is specifically for licensed professionals, such as doctors, lawyers, and in some cases, designers or consultants. PCs provide liability protection for the owners while allowing them to practice their profession.
Pros and cons
PCs offer the liability protection of a corporation with some added flexibility for professional services. However, they’re subject to specific regulations and may have more complex setup and maintenance requirements.
Tax implications
PCs are taxed similarly to regular corporations, with profits subject to corporate tax and dividends taxed at the personal level. Owners can also pay themselves a salary, which is subject to payroll taxes.
Impact on client relationships
Operating as a PC can enhance your credibility, especially if your freelance work is tied to a professional license or certification. It signals a high level of professionalism and commitment to maintaining standards in your field.
Why should I learn about these business entities?
Understanding which business entity is right for you is essential for several reasons, especially for freelancers and small business owners.
Here's why each aspect is important:
1. Liability protection
Knowing the liability implications of each structure helps protect your personal assets (like your home and savings) from business-related debts, lawsuits, or other financial issues. This protection is especially helpful to have in industries where you may face higher risks of client disputes or legal challenges.
For instance, if you operate as an LLC or S-Corp, your personal assets are generally safe if your business is sued. In contrast, as a sole proprietor, your personal assets are at risk.
2. Taxation
Different structures have different tax obligations, which can significantly impact your income and how much you owe the government. Understanding these comparisons allows you to choose a structure that minimizes your tax burden and aligns with your financial goals.
Here’s a situation: While sole proprietors must pay self-employment taxes on all business profits, having an S-Corp might help you save on self-employment taxes by allowing some income to be distributed as dividends (which aren't subject to those taxes).
3. Control and management
The structure you choose determines how your business is managed and how much control you have over decisions. It also affects how you handle day-to-day operations and strategic planning.
As a sole proprietor or LLC member, you have direct control over all decisions. By contrast, in a corporation, especially a C-Corp, decisions might be influenced or made by a board of directors, which can be beneficial for large-scale growth but may reduce your day-to-day control.
4. Formalities and record-keeping
Corporations and LLCs often require more formalities, such as regular meetings, detailed record-keeping, and annual reports. These are necessary for maintaining your business's legal status and protecting your limited liability.
A C-Corp requires more rigorous compliance with corporate formalities than an LLC or sole proprietorship, but this also reinforces the separation between the business and personal assets, protecting you in legal matters.
5. Client perception and business growth
The business structure you choose can affect how clients perceive you and your ability to scale your business.
For example, larger clients may prefer to work with an LLC or corporation because of the added professionalism and legal protections. If you have an LLC, then you can open doors to bigger projects or clients who require a formal business entity for contracts.
6. Ease of setup and maintenance
Different structures have varying levels of complexity and ongoing maintenance requirements. Understanding these can help you choose a structure that matches your willingness and ability to manage these aspects.
Frequently asked questions about business entities
When you’re starting out as a UX freelancer, it’s natural to have a lot of questions — especially when it comes to choosing the right business structure and dealing with legalities.
Here are some of the most common questions freelancers ask, along with our answers to help you make informed decisions.
Do I need to create a business entity to start freelancing?
Not necessarily. Many freelancers start as sole proprietors, which means you don’t create a separate business entity — you’re essentially running your business as yourself. It’s simple and doesn’t require much paperwork. However, as your business grows, you might consider forming an LLC for liability protection.
If I set up an LLC, do I have to register it in the state where I live?
Generally, yes. You should register your LLC in the state where you’re doing business. While some states, like Wyoming, offer lower setup costs (as low as $50), you might still need to register in your home state if that’s where you’re primarily operating.
Going through this route typically involves additional fees and paperwork, so it’s often simpler to register in your home state from the start.
Can I set up an LLC in one state and do business in another?
Yes, but it can get complicated. If you set up your LLC in a state different from where you’re doing business, you may need to register as a “foreign LLC” in the state where you’re operating. Doing so could involve additional fees and administrative work. For most freelancers, it’s easiest to set up and register the LLC in the state where you live and do business.
Do I need to file separate tax returns if I have an LLC?
It depends. If you’re a single-member LLC, you don’t need to file a separate federal tax return — the LLC’s income and expenses are reported on your personal tax return using a Schedule C.
However, if you choose to be taxed as an S-Corp, or if you have a multi-member LLC, you’ll need to file a separate tax return for the business.
When should I consider forming an LLC instead of sticking with a sole proprietorship?
Consider forming an LLC when your business starts generating significant income, or if you’re concerned about liability.
An LLC provides a layer of protection for your personal assets, which can be crucial if you’re taking on larger projects or clients. It’s also smart if you want to separate your personal and business finances.
Do I need a separate business bank account for my freelance work?
It’s highly recommended, especially if you’re operating as an LLC or corporation. A separate business bank account helps keep your finances organized and makes it easier to track income and expenses.
It’s also important for maintaining the liability protection offered by an LLC — mixing personal and business finances can weaken that protection.
If I work with clients in other states, do I need to register my business there?
Not usually. If you’re providing services online or remotely, you typically don’t need to register in each state where your clients are located.
However, if you physically go to another state to conduct business or have a significant presence there, you may need to register as a foreign LLC in that state. The rules can vary, so it’s a good idea to consult with a legal professional if you’re unsure.
Do I need business insurance as a freelancer?
It depends on the type of work you’re doing and your clients’ requirements. UX research and design generally have lower risks, so insurance might not be necessary. But some clients may require you to carry professional liability insurance (also known as errors and omissions insurance). It’s worth considering getting insurance if you’re working on high-stakes projects or with larger clients.
What if a client asks me to sign a non-compete agreement?
Non-compete agreements are more common for employees than for freelancers, but they can still pop up. If a client asks you to sign one, carefully review the terms, as it could limit your ability to work with other clients in the same industry. It’s a good idea to consult a lawyer before agreeing to any non-compete clause to ensure it’s fair and reasonable.
Should I hire a lawyer or accountant when setting up my business?
While you can handle many aspects of setting up your business on your own, hiring a lawyer or accountant can save you time and potential headaches. They can help ensure that you’ve got a clear grasp of the legalities of your business structure, contracts, and tax filings are done correctly, giving you peace of mind and allowing you to focus on your work.
