Independent contractors are not required to form business structures for their work. If they wish, they can continue working as a contractor for as long as they want, and they will be sole-proprietors by default.
However, there are plenty of independent contractors out there who choose to form an LLC or S-corp. You may be wondering why they are doing it and if you should also follow suit. If this is your case, then you have come to the right page. Here, you will know more about LLC and S-corp and whether you should go for any of it as an independent contractor.
What is LLC?
LLC stands for Limited Liability Company. It is a type of corporate structure that safeguards owners against being personally pursued by its debts or liabilities. The rules and regulations of LLCs vary depending on where you establish your business.
Any individual or entity can be a member of an LLC. Moreover, LLCs do not directly pay taxes for their profits. Instead, the members who report the figures on their individual income tax returns carry over the profits and losses.
What is S-Corp?
S-corp is also known as S subchapter. This type of corporation is designed in accordance with the Internal Revenue Code requirements. Basically, this form of corporation allows companies with less than 100 shareholders to enjoy the benefits of incorporation while being taxed as a partnership.
S-corp shareholders can either be specific trusts, individuals, or estates. They can also be tax-exempt organizations. These shareholders’ individual income tax returns must report the income and losses they will pay tax for at ordinary rates.
Do Independent Contractors Need to Establish an LLC or S-corp?
Independent contractors are considered as sole-proprietorship or self-employed individuals. They are also known as 1099 works, and they can be sued for inactions or actions about their work. With this in mind, although opting for a sole proprietorship is the most economical option, your personal assets can be a risk if somebody succeeds in suing you. This is why it is highly recommended to incorporate as an S-corporation or as an LLC in some instances.
As an LLC, your company is considered as a separate individual. This is why if somebody sues you, your personal assets are safe from potential danger. There’s also a taxation benefit if you choose to incorporate as an LLC when you’re an independent contractor because you can avoid double taxation. But, take note that your LLC default tax is much similar to sole-proprietorship in a way that you have to pay 100% self-employed tax corresponding to your income.
On the other hand, if you want to protect your personal assets and lessen your taxes, then incorporating as an S-Corp is also a good option. The difference between LLC and S-corp is that you are considered as one of the employees. This means that you can take out dividends and be paid with a salary, reducing the amount of your taxes. In some states, it is even possible for you to fire yourself if you want to collect unemployment benefits.
Although it is not mandatory for Independent contractors to establish an LLC or S-corp, it has many benefits, especially in terms of personal asset protection and taxation. This makes it worth considering.
How to Establish an LLC or S-corp as an Independent Contractor?
Here are the steps on how to establish an LLC as an independent contractor:
- Choose A State
You can pick any state even if you will not be doing business there. But, ideally, you should form it where you are planning to do business for more convenience.
- Pick a Name
The name of your LLC must not yet exist in the records of the Secretary of State. You can conduct an LLC name search on your state’s website to know its availability.
- Hire a Registered Agent
You need to have a registered agent when you are forming or registering an existing LLC in a foreign state.
- Have an LLC Operating Agreement Ready
This is a requirement for most of the states. This agreement is among members of the LCC and it details how the business should operate.
- File Your LLC
You have to file your Certificate of organization to the Secretary of state to officially create your LLC.
Here are the steps on how establish an S-corp as an independent contractor:
- Create a Business entity
You first need to register your business so that the IRS will consider you as an S-corp.
- Check Whether Your Qualify for an S-corp Status
There are several requirements for you to be considered as an S-corp. It’s best to check the specifics according to your state and start complying with them.
- File an IRS Form 2553
You need to file an IRS form 2553 once your corporation is formed. It should be no later than 2 months and 15 days after your tax year starts.
Take note that establishing an LLC and S-corp might vary, depending on which state that you plan to apply to. At the same time, there might be a slight difference in terms of the tax benefits as well. This is why it’s highly recommended to do extra research about the registration and benefits of incorporating in your state.
Being an independent contractor has a lot of benefits. But, it also comes with its fair share of risks, such as the possibility of being sued. It is worth considering establishing an LLC or S-corp to provide yourself and what you work hard for an extra layer of protection. Although it might require tedious steps and additional paperwork, the benefits it offers make it worth it.