Independent contractors have all the flexibility in the world when it comes to their work schedule, but without an LLC, they may be putting their business and themselves at risk. Simple and generally inexpensive to form, LLCs offer a layer of asset protection for the owner, helping independent contractors avoid the consequences of potential lawsuits or bankruptcy.
What is an Independent Contractor?
An independent contractor provides paid services for a person or business but is not an employee. Unlike employees, contractors usually work specific, short-term projects for a set or hourly rate (not a salary). Clients of independent contractors don’t withhold taxes or provide benefits like health insurance. And unlike employees, independent contractors:
- Are their own boss. You get to decide who you work for, and the people who pay you are your clients, not employers. Your clients have control over the work you perform for them, but not how it is completed.
- Provide their own tools. An independent contractor generally furnishes their own tools and materials in order to provide services. Whether it’s mechanic work, computer repair, or design services, you’re responsible for the tools necessary to do the job.
- Can take on multiple clients at once. As an independent contractor, you’re not tied to just one client, and can work for a number of customers at once.
- Operate like a small business. As an independent contractor, you are your own business, and thus, you’ll pay taxes like a small business. You’ll get 1099s from clients, pay estimated quarterly taxes, and be responsible for keeping track of expenditures and tax write-offs.
- Don’t have employment benefits. Your client doesn’t have to provide you with health benefits, vacation, or a 401k. You’re on your own for those perks.
Independent contractors are usually skilled workers specializing in a trade, such as carpentry, accounting, or graphic design.
The term “independent contractor” defines the way you receive income and your relationship to the people or businesses you do work for. It’s not any particular kind of business structure. That means that independent contractors have the freedom to choose the business structure that works the best for them—and many contractors choose an LLC.
Independent Contractor vs LLC
LLCs are one of the most popular business structures for small businesses, including independent contractors.
Independent contractors, like most small business, tend to start out as sole proprietorships—single-person businesses that don’t require state-level formation paperwork. But as independent contractors develop their business, however, they often find they need more. And while LLCs require a bit more time and money to operate, the benefits they offer can be significant.
Advantages of an LLC for Independent Contractors
Asset Protection
The LLC wears many hats, but one of its most important feature is that it protects the business owner’s assets. By registering your business as an LLC, you sever the direct connection between your business and you as an individual. Your business is a completely independent entity, and your personal finances aren’t typically on the line for lawsuits or other liabilities. For example, if you’re a plumber and you flood a client’s basem*nt, your client can sue your business for damages, but your personal assets—like your home, vehicles and bank account—are generally out of reach.
Why not just purchase business liability insurance? While business owners should definitely bolster their liability protection with a business insurance policy, it is not nearly as robust without an LLC. We’ve all dealt with insurance companies, and they can be really picky about what they actually cover. While the LLC is designed to insulate you, insurance is meant to compensate you. Both are good, but one is better.
Tax Flexibility
Another big perk of being an LLC is that the IRS allows you to choose the way your business will be taxed. The most straightforward option for independent contractor taxes is the default classification—either a disregarded entity (like sole proprietorship) or a partnership (if you don’t own the LLC solo). However, as an LLC, you can also choose to be taxed as an S Corp in order to try to save some money on self-employment taxes.
With default classification, all of your income is subject to 15.3% (Medicare and Social Security) self-employment tax. With an S Corp, however, you must pay yourself a “reasonable salary”—but additional profits can be classified as distributions, which aren’t subject to self-employment taxes.
Professional Image
There’s just something about an “LLC” following your company name that lends your wedding planning business added credibility in the eyes of customers, vendors, and the wider business community. Forming an LLC can help instill confidence and trust for the independent contractor who is looking to bring a professional image to their work. Sure you can enhance your image by registering a DBA for “Johnny’s Power Washing,” but a DBA is nothing more than a name, and offers no liability protection from lawsuits. No need to take half measures when the LLC is the perfect vehicle to enhance your image and provide a layer of protection from frivolous lawsuits and bankruptcy.
Disadvantages of an LLC for Independent Contractors
Time and Money
Forming an LLC isn’t free, and depending on which state you incorporate in, you could be on the hook for a significant filing fee. For example, while Michigan only charges $50 to register an LLC, Massachusetts dings you for $500. Plus, depending on the state, the actual process of registering your LLC may take anywhere from 24 hours to a few days or even weeks before all the paperwork is finalized.
Annual Maintenance
Almost all states require annual or biennial reports. They serve as a way for the state to check in with your business to see if any of the information has changed, or even if your business is still up and running. Often you simply fill out a few forms, pay filing fees, and boom, your LLC remains in compliance with your state.
Most of the time the report fees aren’t too bad, with prices ranging from $10 to $100. But then you’ve got states like Tennessee and Massachusetts that hit you for $300 (minimum!) and $500 respectively (or disrespectively). And states like California charge at least $800 in additional LLC taxes and fees each year.
The Finish Line
Independent contractors aren’t required to form a state-level business entity like an LLC, but the benefits are often just too good to pass up. LLCs are generally cheap to form, don’t require a ton of maintenance, protect your assets, and offer potential tax savings.
If you’re an independent contractor and you’re thinking about starting an LLC, Northwest Registered Agent can help. We can have your LLC up and running as fast as your state will allow.
