As an entrepreneur seeking to establish or expand a business, it often becomes a difficult decision whether to set up your entity as an independent contractor or a Limited Liability Company (LLC).
There are subtle differences between these structures, but they will impact your business on a larger scale. Before starting your journey, it is essential to decide between the two.
This article will throw light on the independent contractor vs. LLC debate.
Who are Independent Contractors?
An independent contractor is a self-employed individual recruited by another entity or firm on a contractual basis to perform a task or offer services but not as an employee of that organization.
In most cases, independent contractors act as consultants delivering specific services in their field of expertise. Unlike a sole proprietorship, they deal with services rather than offering products.
Since independent contractors are essentially freelancers, firms are not obliged to offer them benefits like health insurance or retirement bonuses.
What is an LLC?
As an entrepreneur, you can also register yourself as an LLC, or Limited Liability Company, if you wish to reduce the liabilities of your business on your personal account.
You will be considered a separate entity from your business by registering yourself as an LLC. Thus, only the assets owned by your company are considered financial liabilities, while those of the owner(s) and members come under personal assets.
If the company faces legal troubles, an LLC offers a certain degree of protection to the owners and members – it is solely responsible for any action taken in the legal domain.
Independent Contractors vs. Sole Proprietors
In most cases, independent contractors are sole proprietors and need not register their businesses with the state. They may or may not adopt any business structure and work on a contractual basis as freelancers.
Sole proprietors have their business identity separate from their regular personal expenses. Thus, they must track business expenses and income and pay self-employment taxes by filling up the requisite form.
Independent Contractor vs. LLC
There are several differences between independent contractors and LLCs, including:
An independent contractor need not register with the state. However, LLCs need specific documents to register, such as articles of organization along with liability protection. LLCs must also pay a fee to the state for registering their business.
Independent contractor vs. LLC taxes
The taxation system for LLCs is somewhat between sole proprietors and corporations. Corporations need to pay taxes as individual business entities, while sole proprietors have to take care of their self-employment taxes. While an LLC with multiple partners is taxed as a partnership or corporation, independent contractors must only pay self-employed taxes. Thus, an independent contractor must fill out form 1099 at the end of every financial year.
When choosing an insurance plan, the personal finances of an independent contractor may be at stake, whereas an LLC’s finances are not affected even if someone sues them. However, the latter’s insurance requirements may differ according to the number of their partners or staff.
How Does the Taxation of Independent Contractors Differ From LLCs?
When it comes to taxation, the difference between independent contractors and sole proprietors becomes highly nuanced. For instance, if you sell a product online, you are considered a sole proprietor. However, if a firm hires you as a consultant for designing the same product, you are referred to as an independent contractor.
When considering the LLC vs. independent contractor taxation aspect, you must remember that LLCs fall between corporations and sole proprietorships. Their taxation varies with the number of members in the organization. For instance, an LLC owned by one individual can file taxes as a sole proprietor with Schedule C, whereas an LLC with multiple owners is taxed like a partnership. Each owner of the LLC must fulfill specific requirements, including the K-1 and 1061.
On the contrary, since sole proprietors and independent contractors operate alone, they only pay taxes on their business income.
Another important tenet of the independent contractor vs. LLC debate is the difference between an employee and an independent contractor. For instance, at the end of a fiscal year, a US employee has to fill out a W-9 form. In contrast, an independent contractor gets a 1099 form and a Schedule C. Furthermore, in an LLC, the employers contribute a share in the payment of Federal Insurance Contributions Act (FICA) taxes. However, independent contractors and sole proprietors must bear the entire tax burden themselves.
Why Should Independent Contractors Consider Establishing an LLC?
If you are an independent contractor working as a freelancer or a sole proprietor, you may be quite content with the simplified process of billing, invoicing, and enjoying full profits earned from your projects. Considering the risks involved and the tax benefits of an LLC, you may want to form an LLC.
As an independent contractor, you will appreciate the simplified taxation, operations, invoicing and reaping full profits of the business. However, there are numerous benefits you get by establishing an LLC.
Here are some reasons why an LLC as an independent contractor may be the best choice for your business.
Protection from liabilities
One of the biggest risks of working as an independent contractor is that all your personal assets will be at stake if a client takes legal action against you. It may also include assets that aren’t a part of your business, including your home, vehicle(s), and even your savings account.
But when you operate as an LLC, your personal assets are not at stake. Your organization is liable for all the risks involved – you and your business are separate entities. In such cases, the benefits of LLC vs. independent contractor steer in favor of an LLC.
Simplified taxation system
As mentioned earlier, the tax benefits of LLC vs an independent contractor are vastly different. As an LLC owner, you can claim all your company earnings on your personal income statements and avoid the double taxation system of corporations. You only need to report your profit and loss statements on the relevant form (as applicable in your country of operation) and attach this with your income returns for filing your taxes. This protects you from legal liabilities without impacting your income. If you opt for the S-Corporation taxation system, you need not shell out the entire amount of your self-employment tax, thus saving substantial money.
An LLC as an independent contractor gives you greater credibility as it helps you handle multifaceted business challenges much better than a sole proprietor or independent contractor. Plus, you become the holder of a credible business account with the LLC label.
Business bank account
When you register yourself as an LLC, you can open a bank account in your business’ name. As an independent contractor, you can pay off your self-employment tax through a personal credit card. However, if you wish to add your friends or family members as business partners, you cannot do so.
With an LLC business account, you can add members and it is much easier to keep track of income, payments, and returns. Thus, calculating your profits and making financial projections become much easier. Moreover, IRS audits are complex with a personal bank account, but with a business account, the complete data of your financial transactions is available in one place.
New payment modes
Another benefit of an LLC over an independent contractor is that your clients can opt for their preferred payment mode – checks, online, or wire transfers. However, independent contractors using their personal accounts might face restrictions on the payment amount or methods.
Forming an LLC or working as an independent contractor involves numerous legal aspects that may be difficult to understand. It’s best to hire a global PEO provider like Multiplier to guide you through the complexities of starting and running a business.
Partnering with our digital platform ensures seamless payroll management, legal contract drafting, and international employee onboarding. Our team is well-versed with the intricacies of the independent contractor vs. LLC debate and can help you make the right choice.
Q. Is LLC always a single-member establishment?
No, LLC can have multiple members while an independent contractor always refers to a single-person establishment.
Q. Are sole proprietorship and independent contractor the same?
No, both are separate models but an individual can actually be both.