Differences Between Sole Proprietorship & Freelance
Many sole proprietorships perform freelance work, and many freelance workers are sole proprietors, but these terms are not synonymous. In fact, they refer to entirely different aspects of business. One refers to the legal status and structure of a business; the other refers to the business relationship between a self-employed worker and a client.
A sole proprietorship is an unincorporated business owned by a single individual. That single owner receives all the profits, and the government taxes those profits as the owner's regular income. The owner is also personally responsible for all debts of the business. Legally, there is no distinction between the business and the owner, meaning that the business's creditors can try to seize the owner's personal assets to settle unpaid debts. Sole proprietors can gain some protection for their personal assets by converting their business to a limited liability company or corporation.
Freelance workers are individuals who sell their services to clients but don't have an employer-employee relationship with any of those clients. Freelancers are self-employed. (The name comes from Sir Walter Scott's 19th-century novel "Ivanhoe," in which a "free lance" was an unaffiliated medieval knight available for hire.) They set the terms of their work with each client. Sometimes they sign formal contracts outlining the work to be done, making them independent contractors. Other times, they do work based on oral agreements. Some produce work on their own and then shop it around to potential clients.
The sole proprietorship is the most common type of business in the United States. A 2011 study by the Treasury Department found that of roughly 24.2 million tax returns filed by business operators for the 2007 tax year, about 10.7 million were sole proprietorships. Since freelancers are self-employed individuals for hire, it's common for them to operate as sole proprietors. However, freelancers whose work could expose them to legal liability -- for example, a freelance journalist who might commit libel -- may want to consider incorporating or forming a limited liability company to protect their personal assets.
Freelancers are cheaper to a company than regular employees. Since they're self-employed, freelancers must pay 100 percent of their Social Security and Medicare taxes, rather than splitting them with an employer, and they receive no employee benefits. This makes it tempting for companies to try to reclassify employees as independent contractors. The Internal Revenue Service and the Department of Labor have guidelines for who counts as an employee and who counts as a contractor. In general, the distinction comes down to how much control the employer or client exercises over how the worker performs the contracted job.