Why Every Independent Contractor Should Set Up an LLC (and Consider S-Corp Status)
Post #46: For freelancers, gig workers, temporary workers, contractors, sub-contractors, 1099 Workers... that's you!
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Did you know…?
As of 2023, approximately 64 million individuals in the United States were working as Independent Contractors which represents about 38% of the U.S. workforce. (source)
“Independent Contractors” are also known as:
Freelancers
Gig Workers
Temporary Workers
Contractors
Sub-Contractors
1099 Workers
In this newsletter, I’ll share more about what it means to be an Independent Contractor and why you really should be working under a Limited Liability Company (LLC) and possibly even as an S-Corporation (S-Corp).
Specifically:
What is an Independent Contractor?
What does 1099 mean?
Why do employers prefer to hire Independent Contractors?
The benefits of being an Independent Contractor
The risks of being an Independent Contractor without an LLC or S-Corp
Why an LLC is the first step
Why you should consider S-Corp status
👉 Also, be sure to check out these resources:
Bootstrap Your Business Workflow - a step-by-step guide with the links to all of the top daily posts that walk you through the process from scratch
BYB Book Recommendations - a collection of the best business books to help you on your entrepreneurial journey
BYB Alerts & News - urgent updates for self-employed and business owners - delivered to your inbox - so that you can be more prepared
BYB Documents - a repository of guidance for important business documents with instructions and guides to use them in your self-employment journey
If you’re an Independent Contractor, you likely enjoy the freedom of being your own boss. Or, maybe your employer hired you as an Independent Contractor to reduce their risks and costs.
Whatever the reason for being an Independent Contractor, there are important financial and legal considerations which you may not have considered.
What Is an Independent Contractor?
An Independent Contractor is someone who works for themselves rather than being employed by a company.
Tip: Per the IRS:
“The general rule is that an individual is an independent contractor if the person for whom the services are performed has the right to control or direct only the result of the work and not what will be done and how it will be done.”
Unlike traditional W-2 employees, Independent Contractors provide services on a contract basis and are responsible for their own taxes, benefits, and business operations.
What Does 1099 Mean?
The term "1099" refers to IRS Form 1099-NEC, which businesses use to report payments made to Independent Contractors.
Much like W-2 refers to full time employees, 1099 is a quick way to refer to the employment status of an individual within an employment setting.
If you earn $600 or more from a client in a year, they are required to send you a 1099-NEC form.
Unlike W-2 employees who have taxes withheld from their paychecks, Independent Contractors are responsible for paying their own taxes, including self-employment tax.
Why Do Employers Prefer to Hire 1099 Workers?
This is where the rubber meets the road.
Many businesses prefer hiring Independent Contractors instead of full-time employees for several reasons:
Reduced Liability. Employers can hire and let go of Independent Contractors without dealing with employment laws that apply to W-2 employees, such as wrongful termination protections.
Lower Costs. Employers avoid paying for benefits like health insurance, retirement plans, and unemployment insurance, which can significantly reduce labor costs.
Flexibility in Hiring. Companies can bring on Independent Contractors for short-term projects, seasonal work, or specialized expertise without committing to a long-term salary.
Reduced Administrative Burden. Businesses don’t have to withhold payroll taxes or comply with as many employment regulations when working with Independent Contractors.
Access to Specialized Talent. Companies can hire highly skilled professionals for specific tasks without maintaining them on payroll year-round.
Project-Based Roles. Employers hire Independent Contractors when the individual's role or work period is tied directly to a contract the employer has signed with a client. When the contract ends, the role ends.
These benefits make independent contracting appealing to businesses and employers, but it also means that Independent Contractors must take extra steps to protect themselves financially and legally.
The Benefits of Being an Independent Contractor
Before making any judgements about a company that prefers to hire people as Independent Contractors solely to reduce their costs and liabilities, there are many reasons that make this arrangement an amicable 2-way street.
Freedom & Flexibility. You control your schedule, the clients you work with, and the projects you take on.
Unlimited Earning Potential. Your income isn’t capped by a salary. As an Independent Contractor, you can charge what you’re worth and take on multiple clients.
Tax Deductions. You can deduct business expenses such as home office costs, equipment, travel, training and education, and health insurance, which can significantly reduce your taxable income.
Work-Life Balance. You have greater autonomy over your work environment and lifestyle choices.
Ability to Scale Your Business. With the right contractual agreements, you can earn more money through subcontractors working for you.
The more you learn about the benefits of working as an Independent Contractor, the more likely you will be to pursue this kind of work.
Now, let’s talk about what you need to do to cover your bases.
The Risks of Being an Independent Contractor
(without an LLC or S-Corp)
While freelancing has many benefits, working as a Sole Proprietor without an LLC or S-Corp can expose you to financial and legal risks.
Unlimited Personal Liability. If you don’t form an LLC, there’s no legal distinction between you and your business. That means if a client sues you, your personal assets (house, car, savings) are at risk.
Higher Taxes. As a sole proprietor, you pay self-employment tax (15.3%) on all of your net earnings. Without an S-Corp election, you’re taxed on everything you make, not just what you take as a salary.
Less Professional Credibility. Clients may take your business more seriously if it operates as an LLC rather than just your personal name. An LLC provides legitimacy and can help you win higher-paying contracts.
Limited Business Growth. Without an LLC or S-Corp, you may find it harder to scale your business, secure financing, or establish business credit.
💡 Tip: learn more about LLCs and S-Corps:
Why an LLC Is the First Step
An LLC (Limited Liability Company) separates your personal and business assets, protecting your personal wealth in case of lawsuits or debts.
It’s also simple and inexpensive to set up in most states.
Why You Should Consider S-Corp Status
Once you start earning $50,000 or more, electing S-Corp status can save you thousands in taxes each year.
Here are just a few of the reasons to consider:
Reduce Self-Employment Tax. As a sole proprietor or standard LLC, all your income is subject to self-employment tax (15.3%). With an S-Corp, you can pay yourself a “reasonable salary” and take the rest of your earnings as distributions, which are not subject to self-employment tax.
Tax-Efficient Salary Structure. The IRS requires you to take a reasonable salary, but anything beyond that amount can be classified as a distribution, significantly reducing your tax liability.
Corporate Veil Protection. Like an LLC, an S-Corp provides legal protection by separating your personal assets from your business. This means that if your business is sued, your personal savings and property are shielded.
Potential State Tax Savings. Some states offer additional tax benefits for S-Corps, making it even more cost-effective than an LLC alone.
Retirement & Healthcare Benefits. S-Corps can provide tax advantages for funding retirement accounts (like Solo 401(k)s) and writing off health insurance premiums, further reducing taxable income.
S-Corp Example (Tax Savings)
Let’s say you make $100,000 in profit.
As a sole proprietor, you’d pay $15,300 in self-employment tax (15.3%).
As an S-Corp, you could pay yourself a $50,000 salary (subject to payroll tax) and take the remaining $50,000 as distributions, saving over $7,000 in self-employment taxes alone.
It sounds complicated, but it’s really quite simple.
Next Steps
Setting up an LLC and electing S-Corp status is one of the smartest moves you can make as an Independent Contractor.
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