Many of us have at least a couple of friends or acquaintances who are working independently and reporting to no one but themselves. Working for yourself sounds fantastic! But is it a safe and stable way to earn? What kind of paperwork does it assume? Do I need any licenses? You can have plenty of questions about the way they work and earn. In this guide, we will go over the process, pros, cons, taxes, and everything else you need to know to become an independent contractor.

What is an Independent Contractor?

In ordinary language, an independent contractor is an individual or a business that provides either goods or services based on a contract or agreement. The independent contractor providing services for a company is not considered an employee for that company.

The legal definition for being an independent contractor (according to the IRS) is that the payer cannot control the process and details of the work, all the payer can do is directing the end result.

So, as an independent contractor, you have the right and freedom to decide how you will do the work and what exactly will be done. These two are usually not defined in your contract with your payer. Your contractual obligations are limited only to the end result, quality, and timing.

What Do You Need to Become an Independent Contractor?

In the eyes of the Government, the independent contractor is still a legal entity and a taxpayer. Thus, the activities of independent contractors are regulated, licensed, and taxed.

Requirements for Working as an Independent Contractor

First of all, your activities and legal status need to comply with the Independent Contractor requirements laid out by the IRS and state authorities.

Unfortunately, there are no universal sets of requirements and criteria to determine your status as an independent contractor. Some types of business activities lay in the gray area between employment and independent business. There is also a difference between the definitions and criteria of different states.

However, these are the factors that can help you determine your status:

• Working with multiple clients instead of one.
• Not being instructed by hiring companies on the process and work details.
• Covering business expenses by yourself (e.g. rent for the office, equipment, materials, etc.).
• Not receiving employee benefits from hiring firms, such as health insurance and vacations.
• Controlling your schedule.
• Doing your own marketing.
• Paying your own taxes.
• Working outside the hiring company office.

Do Independent Contractors Need a Business License?

The quick answer is – it depends. There are differing state requirements. It also depends on the type of activity and service you are providing. For instance, if you are a medical professional, lawyer, or you will almost definitely need a license to operate. And we can understand why. These are professions with a high degree of responsibility, and making mistakes can have dire consequences. On the other hand, if you are a plumber, most states will let you provide your services without a license.

In any case, the majority of states will require you to have a business license and register as a business. The main reason behind this is tax revenue. States will definitely want you to declare your income and pay your taxes.

What are the IRS Rules for Independent Contractors?

The IRS used to have a long list of 20 rules to determine your classification as an independent contractor or an employee. This method is deprecated now and the taxation authority uses a more simplified set of rules now.

These are the three factors that the IRS will take into consideration:

1. Behavioral: Can the hiring company control the details of your work?
2. Financial: Are the financial aspects of the job controlled by the payer? This can include the company’s decision to reimburse expenses or buy equipment and materials for work.
3. Type of relationship: Is there a contract? Are there employment-specific benefits?

Steps to Become an Independent Contractor

As independent contractors are still legal entities and taxpayers in the eyes of state governments and the IRS, you will need to take several steps before you can legally start providing your services.

In order to become a legally registered independent contractor, you will need to perform these tasks:

1. Decide the legal type of your business: you can open a Limited Liability Company, form a Corporation, Partnership, or simply become a Sole Proprietor.
2. Apply for a Tax ID and perform other necessary tax-related registrations: any business operating in the U.S. should have a Tax ID. This is mandatory even if you do not have any tax obligations. In case you are selling products that are subject to state taxes, you will need to register with the state tax authorities as well. Other than the income/profit tax and sales tax, you might also be subject to other taxes.
   • If your business owns a property, you will need to pay property taxes.
   • As you are self-employed, you will also need to pay Social Security and Medicare taxes for yourself.
   • Depending on your activity, you might also need to pay franchise taxes or gross receipts tax.
3. Register the name of your business: what if someone else is already using that name? You need to perform the registration to make sure that you are the only business with that name. If the name of your company and business name are different, you will also need to register a trade name.
4. Open a bank account for your business: having a business account is more about better management than legal compliance. Vendors and suppliers will trust you more if they transact with your business account. You will be able to differentiate your personal finances from those of your business and file for a business tax return.
5. Set up your bookkeeping: keeping records of your finances and activities is essential. You will need to make sure that you have the necessary accounting software, as well as sales and transaction-recording equipment.

Pros of Becoming an Independent Contractor

Why would one leave their salaried job and become an independent contractor? Well, there are plenty of good reasons why. Let’s see how you will benefit from making such a decision:

• Freedom: you set your schedule, accept or reject offers, decide on your office location, and more.
• You are your own boss: there is no need to follow someone else’s directions.
• Potential to earn more: you will not earn a salary and hope for a raise. The better your business does, the more you earn.
• You can deduct expenses: gas for going to work, lunch, and travel expenses, all these can be deducted from your taxes.

Cons of Becoming an Independent Contractor

Becoming an independent contractor seems like a great idea. But are there any downsides to working for yourself? Let’s explore factors that you need to take into consideration before going for it:

• Unpredictability: sometimes there are days in a row without contracts and clients. Unlike employment, if there is no job to do, there is no stable payment either. There is also unpredictable timing. Some clients will pay late, some will pay early, some, even, will not pay until you sue them. So you need to be ready for all of this.
• Taxation becomes more complex: states and IRS will require you to fill out additional tax forms, store your receipts and do bookkeeping.
• Business liability: if you are an employee and the company fails, you lose your job at most. However, failing as an independent contractor means you stay liable for all the debt the business has accumulated.
• No employment benefits: yes, you will have to give up your health insurance, paid vacations, sick leaves, and other perks that regular employees enjoy.

Tips to Get Started

Now that you know the steps, benefits, and drawbacks of becoming an independent contractor, let’s finish this guide with a couple more handy tips for you to use during your journey.

How to File Taxes as an Independent Contractor

We will get a bit technical here. As an independent contractor, you will need to fill in either 1099-K or 1099-NEC forms, depending on the type of your activity. As you are a sole proprietor of your business, you will need to file your company taxes on a Schedule C and claim your income. For calculating taxes on self-employment, you will need to use Schedule SE.

How Set Your Own Pay

Fortunately, there are no legal limitations here. You simply need to decide if you want to pay yourself with regular periodicity (i.e. once per month) or when your clients fulfill the invoice. Just be careful to leave enough money to cover all your business expenses.

To Sum Up

Being your own boss sounds wonderful! It has plenty of benefits but also drawbacks. It requires a bit more paperwork and legal compliance but gives you a lot of freedom. If you understood that becoming an independent contractor is what you want to do, take advantage of this guide to navigate through the complex but very exciting process. Good luck!