If you work for someone but do not have an employer-employee relationship, you are an independent contractor. Independent contractors own their own businesses and provide their services on a contract-by-contract basis to a client.
Some contracts will be one-off engagements, while others can be long-term, steady relationships. As an independent contractor, you can work for one client or many clients at the same time.
One crucial distinction between an independent contractor and an employee is who controls production. As an independent contractor, you can choose how and when to work, rather than being micro-managed by an employer.
What are the Benefits of Becoming an Independent Contractor?
There are numerous benefits of choosing to become an independent contractor, including:
You Are Your Own Boss
As an independent contractor, you can work on your own schedule, choosing what days to work and what hours to keep. You can also work in the style that fits you best, whether that's working in silence or with music blasting. It's all up to you!
You Can Deduct Your Business Expenses
Independent contractors receive payment as a vendor, not an employee. This means that the payments you receive will not have taxes withheld. What it costs you to run your business can be deducted from the taxes you owe.
You Have Flexibility
If a client demands too much or pays too little, you do not need to continue providing your services. You can work as an independent contractor part-time or full-time, or independent contractor work can be your side-hustle.
Steps to Become an Independent Contractor
Once you have determined you should begin self-employment as an independent contractor, a few simple steps will ensure your business is professional and protected.
Decide a Business Legal Type
The first step is to determine the best structure for your type of business operations. By default, independent contractors are treated as sole proprietorships by the tax authorities. As a sole proprietorship, your business income will be reported as personal income on IRS Schedule C. It may be advisable, however, to set up a different business entity, such as:
Partnership If you are going into business with another person or multiple people, a partnership divides your income and liabilities. A partnership's operations are governed by a partnership agreement outlining investments, responsibilities, liabilities, and other duties.
Read more: Terms in a Partnership Agreement
Corporation Corporations are separate legal entities from their owners, both for liability and tax purposes. This means that your personal assets can't be pursued to pay for your business's debts and that the corporation's profits and losses belong to the corporation, not you.
If you start a corporation for your independent contractor business, you'll be taxed as a C corporation (or "C corp”) by default. C corps are separate tax-entities, and their profits and losses are taxed before distributing any dividends to its shareholders. Shareholders then pay personal income tax on any distributions received.
You can also elect to be taxed as an S corporation (“S corp”) instead. An S corp “passes through” all its income, losses, and possible deductions directly to its shareholders. In this way, it avoids the double-taxation of a C corp.
Read More: LLC vs Scorp
Limited Liability Company (LLC) LLCs are a creation of state laws. While most states have written statutes that provide for the formation of LLCs, a few states don't allow LLCs at all. If your state permits LLCs, the process of setting one up will be governed by your state's laws.
LLCs can be owned by one “member” or multiple “members.” By default, the IRS treats single-member LLCs as sole proprietors and LLCs with two or more members as partnerships for tax purposes. LLCs can also elect to be taxed as either a C corp or an S corp.
Like corporations, LLCs will protect your personal assets. This means that If you are sued, only the LLC’s business assets are at risk.
If you are going to work by yourself (with no partners or employees), an operating agreement will be simple. However, a complex, well-defined operating agreement can prevent many disputes that arise once your business has more than one stakeholder.
Your business' structure may also evolve as you grow. A sole proprietorship may have made sense at the start, but increased revenues and expenses may call for a more defined structure.
Choose an Independent Contractor Business Name
Operating with a business name will help you convey professionalism to any prospective clients. Choose a name that is both unique and denotes what services you can provide.
Check your state's Secretary of State's website to confirm your name is unique and available, then register your business name with the state. This will be the name you use for tax purposes with the IRS. You also should check if your state, county, or municipality requires you to operate with a business license.
Apply for a Tax ID Number
Once you have chosen and registered your business name, you can apply for an Employer Identification Number (EIN) with the IRS. As an independent contractor, you will not have taxes withheld from the payments you receive for your services.
This means you will be responsible for:
- Federal income taxes
- Self-Employment taxes, including Medicare tax and Social Security
- State income taxes
- Local income taxes
Your tax burden and required filings will vary from state to state, but it is generally a good practice to pay any federal taxes incurred as an independent contractor quarterly. Talking with an accountant or tax professional will help answer any further questions you may have.
Open a Business Bank Account
Commingling personal funds with business funds is one way independent contractors can get themselves into trouble. A business checking account serves multiple purposes, including:
- Showing the IRS you are separate from your business
- Avoiding putting your personal financial assets at risk
- Simplifying your own record keeping
When starting your business, depositing your personal funds into a business bank account can be seen as an investment. Then, make sure any payments you receive go to the business bank account before transferring them to your personal account. You should never use your business account to pay for personal expenses.
Keep Business Records
Independent contractors do not benefit from the services they would receive as employees of a company. One of these services is record keeping. An excellent independent contractor stakes out a solid business plan from the start. This business plan should include a way to handle record keeping. Whether you choose accounting software or retain an accountant, record keeping can separate the successful from the unsuccessful.
If you have decided to become an independent contractor, the earlier you get started on these five steps, the better. Exceptional skills and client-services will only carry an independent contractor so far. To be truly successful, you need the right name, the correct structure, and proper bookkeeping.
To get started, check out our contract maker. You can use it to create an independent contractor agreement in minutes!
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