Becoming an Independent Contractor

Steps to Starting an Independent Contractor Business

If you are working for yourself, and if you aren't an owner or employee of a corporation, you are an independent contractor. In other words, you are considered self-employed.

If you are self-employed, that means you aren't an employee for someone else, you have your own business, and you are filing your income taxes as a business owner (sole proprietor or another business type). Here's why you should take the steps to set up as a legal business entity and the tasks you need to start your business.

Why Set Up a Business Entity as an Independent Contractor?

Working for others as an independent contractor has benefits and drawbacks.

The benefits:

  • You are truly independent. You can run your business the way you want, with no one telling you what to do. 
  • You get all of the profits of the business. You don't have to share them with anyone.
  • You can decide how much money you take out of the business. Of course, you have to make money first. But you can decide whether to put your profits back into your business or take them for your personal use. 
  • You can take deductions for expenses that are not deductible to you personally, like driving expenses, home business expenses and depreciation on purchases of business property and equipment.

The drawbacks:

  • If you take all of the profits, you also have to take all of the losses. If the business doesn't make money, you have no one to blame but yourself. 
  • You don't have benefits given to employees, like health care. 
  • Paying Social Security and Medicare taxes becomes your personal responsibility (it's called self-employment tax). These taxes aren't withheld from your paycheck like they would be if you worked for someone else.

Decide on Your Business Legal Type

If you are just starting out, you don't have to form a specific business legal type by registering with your state. You can just start taking in money and paying your business bills—and keeping records of your transactions.

When you file the first income tax return for your business, you will be filing as a sole proprietor, and your business income will be included on a Schedule C form to include on your personal tax return.

Some other business type options: 

  • If you are the only owner and you have no employees, you might want to consider forming a limited liability company.
  • If you are selling products or you plan to hire employees, you might want to consider incorporating (forming a corporation).
  • If you are working in professional practice—dentistry, law, accounting, for example—you might want to set up one of the partnership types.
  • If you are a solo contractor performing a service, you might want to start as a single-member LLC.  

Apply for a Tax ID Number and Other Tax Registrations

For every business type, even if it isn't required,​ you should apply for a federal tax ID number for your business (also known as an Employer ID Number or EIN). This number, provided by the IRS, is a unique number for your business and it helps establish you as a business entity.

If you sell taxable products and services in your state (and your state charges sales tax), you will also need to register with your state for state sales tax purposes.

Don't forget to consider other taxes

Register your Business Name

When you have selected a business name, hold off on buying business cards and stationery for a bit. First, check to be sure no one else is using that name. You may want to register your business name with your state, or you may want to consider trademarking the name if it is unique.

You may also need to file a fictitious name (trade name, or d/b/a) statement if your business name is different from the name of your company.

For example, if your name is Carlotta Calvin and your business name is The Calvin Company, you probably don't need a fictitious name filing, but if it's Excelsior Solutions, you do. 

Set up Your Business Checking Account

Getting a business checking account will help establish that your business is legitimate and not just a hobby. It lets people know you are serious about being in business. 

Getting a business checking account also establishes your credibility with vendors and suppliers. For yourself, it helps you keep your business and personal transactions separate to make it easier to see how your business is doing, to create your business tax return at tax time, and keep the data separate for your business financial statements.

Set up Your Business Record Keeping System

If you want to claim business tax deductions for your business expenses on your business tax return, you will need to keep good records. Here's a simple five-step system for business recordkeeping: 

  • First, set up easy ways to capture the information on each business transaction, both income and expenses, such as a point-of-sale system and bookkeeping software.
  • Then, check periodically to make sure you have all the information on each transaction and that it's complete and correct. 
  • Record all transactions in your accounting system (online or desktop) at least once a week.
  • Consolidate and review all the information, using financial reports, like a profit and loss statement and balance sheet.
  • Finally, act on what you have learned, by making good business decisions and preparing for tax time.

To help you better manage your bookkeeping and tax calculations, here are some of the best accounting apps for independent contractors.