Many independent contractors (ICs) start earning money without really planning on it. Before they know it, their sideline projects have become legitimate businesses -- which means that they have to fulfill some basic business start-up requirements. Whenever you provide services and get paid, you must comply with several government rules, even if you work only a few hours per week.
At a minimum, do these four things when you're first starting out as an independent contractor:
First, make sure you are an independent contractor and not an employee. You're an independent contractor if you're in business for yourself. You're an employee if you work for someone else’s business and are subject to their control.
If you're treated like an employee, you should be classified like one by the business you work for. As such, you'll be entitled to employee benefits like health insurance. But you won't get to deduct business expenses like mileage. Employees don't need to take the steps described below. On the other hand, if you want to be an independent contractor, taking these steps will help solidify your status as one.
Unfortunately, there is no exact test to determine if you're in business. The IRS and many other government agencies use the “right of control” test. Under this test, a worker is an employee if the hiring firm has the right to direct and control the way the worker performs—both as to the final results and the details of when, where, and how the work is done. If the hiring firm's control is limited to accepting or rejecting the final results the worker achieves, then that person is an independent contractor.
Factors that show you are an independent contractor include working with multiple clients instead of just one, not receiving detailed instructions from hiring firms, paying your own business expenses such as office and equipment expenses, setting your own schedule, marketing your services to the public, having all necessary business licenses, working outside the hiring firm's premises, not receiving employee benefits like health insurance, paying all your own Social Security and Medicare taxes, and using written independent contractor agreements.
Proper classification can prove particularly difficult for "gig workers" who work for online hiring platforms like Uber, Lyft, TaskRabbit, Upwork, Postmates, and many others. Gig workers are usually classified as independent contractors by their online hiring platforms. The hiring platform’s contract will typically contain a provision that the gig worker is an independent contractor and that the worker agrees to such status.
However, there is debate about whether classifying gig workers as independent contractors is correct. In many cases, the independent contractor classification seems fully justified. This is especially true for workers who have a large measure of control over their work—for example, where the hiring platform allows providers to select or refuse jobs, set their own hours and pay, and control other aspects of their work. On the other hand, some hiring platforms exercise more control over price-setting and assignment decisions than is typical in an independent contractor-client relationship.
Some states, notably California, have tried to make it much harder for gig workers to be classified as independent contractors. Hiring platforms like Uber/Lyft are fighting hard against these efforts. The bottom line: Currently, if you want to obtain work through an online hiring platform, you'll usually have to accept being treated as an independent contractor.
It's a good idea to choose a business name that you can use on your invoices and business cards. Using a business name rather than your own name appears more professional.
Depending on the name you choose, you may have to register it with the government. Any business that doesn't use the legal name of its owner as part of its business name must register the name as a fictitious business name (called an assumed name or a DBA -- "doing business as" -- in some states). This allows customers to easily contact the business owner with a complaint or to take legal action against the business. For example, Madeline Quinn names her consulting business "Madeline Consulting." Because the business name doesn't include her full name, Madeline must register it as a fictitious business name.
There are other reasons to register your business name. First, you won't be able to enforce any contract that you sign under an unregistered name. Second, many banks won't open an account under your business name unless you provide proof that you have properly registered the name.
If you use your full name in your business name, you don't have to register it. For instance, many contractors who run small service businesses simply add a word or two after their full name to come up with a business name, such as Aidan Ray Editorial or Mike Russell Architectural Services. You can start using a name like this without filing any paperwork. For help choosing a business name, see Pick a Winning Name for Your Business.
In most states, including California, you register your fictitious business name at the county level, with the county clerk. Different counties often have different forms and fees for registering a name. (In a few states, such as Florida, you register a fictitious name with a state office, such as the Department of State.)
The best thing to do is call your county clerk's office to find out its procedures, requirements, and fees. For more information, see Registering Your Business Name.
Many cities and counties require every business -- even single-owner, home-based operations -- to register with the local tax collector and obtain a tax registration certificate. This certificate is sometimes called a business license, but it is essentially a receipt for the tax you must pay for the privilege of doing business in a city, and nothing more.
If you operate your business out of your home, you usually need to get a tax registration certificate in the city where you live, even if none of your clients are in that city. Contact your city clerk for an application.
Some independent contractors fail to register, figuring they can stay under the local government's radar. But consider this: Tax registration certificates are inexpensive, while the penalties for operating without a license can be hundreds of dollars. In addition, in some locales it is a misdemeanor to violate city ordinances by operating without a tax registration certificate.
Depending on your trade, you may also have to get a professional or vocational license. For instance, some states license auto mechanics, barbers, massage therapists, and real estate agents. Ask your trade association or go to your state government's website to see if you need a particular license. For more information, see Licenses & Permits for Your Business.
Unlike employees, who have income taxes and other taxes (Social Security and Medicare taxes) withheld from their paychecks, independent contractors have to handle all of their own taxes. This means you have to set aside enough money to pay your tax bill each year. All independent contractors who make more than $400 per year from business activities must report their business income to the IRS. For general information on paying taxes as a self-employed business owner, see How Sole Proprietors Are Taxed.
In addition, if your business is at all profitable, the IRS requires you to pay your taxes in four installments during the year, called paying "estimated taxes." (If you will bring in more than $3,000 in adjusted gross income from business activities in any year, plan on paying estimated taxes.) For more information on estimated taxes, see Paying Estimated Taxes.
If you have a day job, you can avoid making estimated tax payments by asking your employer to increase the income withheld from your paycheck to offset the taxes that will be due on your business income.
Some small-time independent contractors skip paying taxes on their freelancing or consulting income altogether. But before you consider hiding income from the IRS, you should know that penalties and interest on back taxes, especially self-employment taxes, can be quite high. Also, any client who pays you more than $600 by check or cash in any calendar year must report the income paid to you to the IRS, and the IRS will check your tax returns to see whether you are reporting this income.
It's better to bite the bullet and just pay taxes on your business income. By being clever about deducting your expenses, you may not end up paying taxes on much income at all -- independent contractors can deduct many more expenses than employees, often lowering their income by as much as 50% for tax purposes. In addition, sometimes your business activities can produce a tax loss that can reduce your taxable income from other work. For more information, see Operating Losses: Prove Your Hobby Is a Business.
To set yourself up as a self-employed taxpayer with the IRS, you simply start paying estimated taxes (on Form 1040-ES, Estimated Tax for Individuals) and file Schedule C, Profit or Loss From Business, and Schedule SE, Self-Employment Tax, with your Form 1040 tax return each April. You can get these forms from the IRS website at www.irs.gov.
After completing the three basic steps described above, you may start providing services as an independent contractor. Once you get started, you will be running a legitimate business.
As a small business owner, you should learn the basics of bookkeeping and recordkeeping, and you may also want to take marketing steps, such as listing your business in the Yellow Pages and setting up a basic website. For more information, see Nolo's Business Accounting, Bookkeeping and Finance and Sales, Marketing & eCommerce areas.
For everything you need to know about being an independent contractor, get Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Gig Workers of All Types, by Stephen Fishman (Nolo) and remember you can purchase Independent Contract Agreement forms from our online store.