Working for others as an independent contractor has benefits and drawbacks.
- You are truly independent. You can run your business the way you want, with no one telling you what to do.
- You get all of the profits of the business. You don't have to share them with anyone.
- You can decide how much money you take out of the business. Of course, you have to make money first. But you can decide whether to put your profits back into your business or take them for your personal use.
- You can take deductions for expenses that are not deductible to you personally, like driving expenses, home business expenses, and depreciation on purchases of business property and equipment.
- If you have all the profits, you also have all of the losses. If the business doesn't make money, you have no one to blame but yourself.
- You don't have benefits given to employees, like health care.
- Paying Social Security and Medicare taxes becomes your personal responsibility (it's called self-employment tax). These taxes aren't withheld from your paycheck (no paycheck, remember?)
The number of legal types of business is s confusing. If you are just starting out, you don't have to form a specific business legal type by registering with your state. You can just start taking in money and paying your business bills. When you file your first tax return, you will be filing as a sole proprietor, and your business income will be included on your personal tax return.
If you are starting as an independent contractor or freelancer, consider forming a limited liability company. If you are making a product and planning on hiring employees, you might want to consider incorporating.
If you are working in a professional practice - dentistry, law, accounting, for example - you might want to set up one of the partnership entities.
If you are a solo contractor performing a service, you might want to start as a single-member LLC. Learn more about the legal types of businesses so you can talk to your attorney about which is best for you.
Even if you don't plan on having employees in your business, you should apply for a federal tax ID number (also known as an Employer ID Number or EIN). This number is a unique number for your business and it helps establish you as a business entity.
If you sell taxable products and services in your state (and your state charges sales tax), you will also need to register with your state for state sales tax purposes.
Don't forget to consider other taxes:
When you have selected a business name, don't rush out and buy business cards and stationery yet. First, check to be sure no one else is using that name. You may want to register your business name with your state, or you may want to consider trademarking the name if it is unique.
You may also need to file a fictitious name (trade name, or d/b/a) statement if your business name is different from the name of your company. For example, if your name is Carlotta Calvin and your business name is The Calvin Company, you probably don't need a fictitious name filing, but if it's Excelsior Solutions, you do.
Getting a business checking account also establishes your credibility with vendors and suppliers. For yourself, it helps you keep those business and personal transactions separate to make it easier to see how your business is doing and to create your business tax return at tax time.
If you want to claim business tax deductions for your business expenses, on your business tax return, you will need to keep good records. Here's a simple five-step system for business recordkeeping:
- First, set up easy ways to capture the information on each business transaction, both income and expenses.
- Then, check periodically to make sure you have all the information on each transaction and that it's complete and correct.
- Record all transactions in some kind of accounting system (online or desktop) at least once a month.
- Consolidate and review all the information, using financial reports, like a profit and loss statement and balance sheet.
- Finally, act on what you have learned, by making good business decisions and preparing for tax time.
Becoming an Independent Contractor
Steps to Starting an Independent Contractor Business
If you are working for yourself, and if you aren't an owner or employee of a corporation, you are an independent contractor. This means you are self-employed.
Being self-employed means that in this position you aren't an employee and you have your own business, filing taxes as a business owner (sole proprietor or another business type). You should take the steps to set up as a business entity. Here's why you should become a business entity and the tasks you need to start your business.