Maybe you have taken a job as a contractor within the company where you used to be an employee. Or maybe you were hired as an independent contractor to do work for a company. In any case, as a contractor or independent contractor, you are not an employee. You are self-employed.
You should set up your own business identity. Here is why:
Why do I have to set up a business entity if I am an independent contractor? Because you are now self-employed, with all the reality of self employment, and the benefits.
The Reality of Self-Employment
- You will have income, probably in the form of a 1099-MISC, which you must pay taxes on. If you don't set yourself up as a business entity and start keeping a record of expenses so you can deduct them, you will have to pay tax on the entire amount of your income.
- You don't have an employer to withhold federal and state income taxes from your income, so you will need to do your own withholding.
- You must pay self-employment tax (Social Security and Medicare) on your income from self-employment. No one pays this for you, so you must plan to set aside this money (15.2 percent of your profits) to pay with your tax return.
- You have no one to pay your insurance (health insurance, liability protection), so you will have to pay it yourself or do without.
The Benefit of Setting up a Business Entity
- If you set up a business entity such as a sole proprietorship, or better, a limited liability company, you can deduct legitimate business expenses to minimize your tax bill.
- You can also use the deductions to minimize your profit and your self-employment tax.
- You can use your business entity to purchase insurance and take the deductions for this expense, again minimizing your tax bill.
- Setting up an entity minimizes the chance that the IRS will say your business is just a hobby or deny your deductions.
You can set up simply as a sole proprietor, or you can go the next step and register as a limited liability company or other entity. In any case, taking your business to the next level by establishing a business entity separate from your personal finances is worth your time and trouble.