Should an Independent Contractor form an LLC? Learn the differences between contractors and LLCs.
If you’re going into business for yourself, you may be pondering the question of independent contractor vs. LLC. Being an independent contractor requires no registration with the state, but forming an LLC can often be beneficial to independent contractors who want to establish their credibility as a business, protect their personal assets from the liabilities of the business, and have flexibility when it comes to filing their taxes.
An independent contractor is an individual who provides work and services for others through contracts without serving as an employee, whereas a sole proprietor is a business that’s run by a single individual and hasn’t applied with the government to be another type of legal entity, such as an LLC or corporation.
Both an independent contractor and a sole proprietor must keep track of their own tax expenses and file a 1099 form because payroll taxes aren’t deducted from their pay by their clients. In the past, this would often be Form 1099-MISC form, but today businesses use Form 1099-NEC for this kind of reporting. Independent contractors and sole proprietors are not registered businesses; all earnings (profits and losses) are reported on the personal tax return of the owner.
Independent contractors and sole proprietors are personally liable for any business expenses, and their personal assets can be taken if the business can’t pay its debts. If someone sues the business, the sole proprietor or independent contractor is personally liable and risks losing their savings and personal property (home, auto, etc.).
A single-member LLC is an LLC owned and operated by one person. It operates the same way as an LLC with multiple owners (who are called “members”). By default, the LLC is taxed the same way a sole proprietor would be, in that the profits are taxed only at the individual owner level and not the business level. However, LLCs also have the option of being taxed as an S corporation or a C corporation, which can have tax advantages for certain LLCs, especially if they’re more profitable. For example, filing as an S corporation could save the members on self-employment taxes.
A single-member LLC (like all LLCs) helps individuals establish their business while protecting their personal assets from the liabilities and debts of the business. That’s because an LLC is a separate business entity and is considered a legal entity of its own apart from the owners.
Unlike an independent contractor, LLC owners are required to submit business formation documents, such as Articles of Organization, in order to register their business with the state. Nearly all states also require a filing fee for starting an LLC. Many states also require some minor periodic paperwork and fees to be submitted to the state, such as an annual or biennial report.
Independent contractors don’t have to submit such paperwork or pay those fees to the state, but they’re still responsible for tracking and reporting all income made from the business. Businesses that pay independent contractors are required to provide a 1099 to the contractor to include with their taxes. The biggest difference between independent contractors and LLCs is that LLC members have limited liability protection to safeguard their personal assets from the liabilities of the business, while an independent contractor doesn’t.
An independent contractor has full liability, meaning they risk losing their personal assets to cover the business’s liabilities. LLCs provide protection for business owners by keeping their personal assets separate from their business, meaning that, in most cases, they don’t risk losing everything if their business is facing challenges.
A professional limited liability company (PLLC) is a type of business that’s formed by licensed professionals, such as lawyers, doctors, and chiropractors. This type of business entity operates similarly to a limited liability company (LLC), but the main difference is that it’s intended to also protect individual members against malpractice claims against the PLLC’s other members.
If an independent contractor is a sole proprietor, they have only one option for paying their income taxes from the business, which is to report all the business’s profits and losses on their personal tax return. Many small business owners prefer this “pass-through taxation” to the “double taxation” a corporation must pay, in which the profits are taxed at both the business and personal levels.
LLCs have the same pass-through taxation by default, but they also have the option to be considered an S corporation or a C corporation for tax purposes. In some situations, these other tax options could be advantageous. An LLC taxed as an S corporation could lower what its members pay in self-employment taxes, while a large LLC taxed as a C corporation may be able to benefit from more tax deductions (for example, deducting employee health insurance premiums).
Acquiring an LLC as an independent contractor is one of the most cost-effective ways to establish credibility and protect your assets as you grow your business. LLCs offer business owners the ability to be registered and recognized as a business within their state, establish further credibility, protect their personal finances, and unlock tax benefits to help grow their business faster.
An LLC is formed at the state level, so how to create an LLC will depend somewhat on the state you’re forming it in.
Most states follow the same basic steps, which usually include finding a unique name for your business, appointing a registered agent to receive important legal notices on behalf of the company, filing Articles of Organization with the Secretary of State, creating an operating agreement to outline how the LLC will be run, and obtaining an Employer Identification Number (EIN) from the IRS.
Our business formation services can help you get your LLC started with minimal fuss and confusion, all for $0 plus state filing fees. With that and our many other business services, we can help you start, run, and grow your business so you can hit the ground running instead of wrestling with paperwork.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
That will depend on your situation, but many entrepreneurs prefer LLCs because of the personal liability protection and tax flexibility they provide over being an unregistered independent contractor.
Independent contractors, sole proprietors, and LLC owners are all considered to be self-employed. A business owner is generally considered to be a self-employed person. The main difference is that LLCs protect your personal assets from the debts of the business.
Creating an LLC for your 1099 business income is a way for business owners to protect their individual assets, establish business credibility, and have more tax options, though LLCs require being registered with your state and paying some filing fees.
An independent contractor either seeks out or is recruited to work on contracts where there are project guidelines to follow and a set earnings rate. A sole proprietor can also do this, but may also earn money from selling their own products or services. Both face similar challenges, such as managing their own schedule, documenting their income, and being held personally liable for the type of work they complete.
There are other business structures, such as an LLC or corporation, that constitute a formal business entity that’s considered legally separate from the owner. In these business types, business debts are considered separate from the personal debts of the self-employed business owners. Some of these business structures may also offer potential tax savings.
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When it comes to compliance, costs, and other factors, these are popular states for forming an LLC.
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