Independent Contractor vs LLC: Everything You Need to Know
Independent contractor vs LLC refers to the differences between an independent contractor and a limited liability company.3 min read
Updated June 22, 2020:
Independent contractor vs LLC refers to the differences between an independent contractor and a limited liability company. Both are business types, but an independent contractor is comprised of one person, or member, while an LLC can have one or more members.
What Is an Independent Contractor?
Independent contractors provide work and services for others, but they are not technically employees. Usually, independent contractors are creative or technical professionals who specialize in a particular medium like web design, writing, or information technology, among others.
Employees get W-2 tax forms each year that specify their yearly earnings and taxes withheld from their paychecks. Because independent contractors are not employees, they do not receive W-2 forms, but 1099-MISC forms instead. A 1099 (as it's called for short) is a tax form that lists the total income paid to the contractor from a particular company for the year. If a contractor does work for multiple companies or individuals, they'll receive multiple 1099s.
W-2 forms show the various payroll taxes withheld from their pay, but an independent contractor doesn't pay those taxes. A 1099 will not show any tax deductions, because independent contractors are responsible for paying their own taxes at the end of each year. They'll be required to pay self-employment tax like Medicare and social security as well as personal income tax. Independent contractors should keep a close track of their earnings throughout the year and tax percentages so they aren't surprised by what they owe.
Most independent contractors choose to form a sole proprietorship for their work, but they can technically choose other types like:
- S corporation
- C corporation
Their choice will depend on their long-term goals for the services they offer and how many other people they want to get involved in their business. The reason most choose to form sole proprietorships is that they're the simplest business type to form in most states.
Independent Contractors and Sole Proprietors
An independent contractor is not required to form a business structure around their work; they can simply continue working as a contractor for as long as they desire. However, most independent contractors are sole proprietors by default. Sole proprietorships are not registered with the state like other business types. All you need to do to become a sole proprietor is:
- Keep track of business expenses.
- Keep track of business income.
- Pay self-employment and income tax.
Just like any other business, a sole proprietor must keep business and personal income and expenses separate. An independent contractor is a business owner whether they know it or not.
What Is an LLC?
Limited liability companies are a very popular type of business structure. They provide a level of protection for the owners, also called members, of the company in the case of legal action. The assets of LLC members are protected if the company itself comes under scrutiny. Financial liability is limited to only the assets owned by the company and not those owned personally be members. An LLC is held responsible for its actions as its own entity in the eyes of the court.
What Are the Differences Between an LLC and Independent Contractor?
The biggest difference between an LLC and an independent contractor is the fact that LLCs are required to register with the state and form business documents like articles of organization. LLCs also offer liability protection that independent contractors would not have otherwise. Business owners are required to pay a filing fee to the state in which they are registering their LLC, while an independent contractor owes no fees.
Tax Differences Between LLC and Independent Contractor
LLCs are required to pay employer taxes if they have any employees, but independent contractors must only keep track of their own self-employment taxes. When it comes to taxation, LLCs are between sole proprietorships and corporations. A corporation is responsible for taxes as a company, and its shareholders also pay taxes on their shares. This is called double taxation. Sole proprietorships only pay taxes on their individual business income because they have no employees.
An LLC will be taxed differently if it has only one member than if it had multiple. Single-member LLCs are taxed like sole proprietorships, but multi-member LLCs are taxed more like partnerships.
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