You’re a contractor and people are paying you to work in your pajamas. It’s a life of luxury, but when tax time comes, you are in a world of hurt and you wonder why you even do it. Taxes are tricky, but there are some tools you can use to make it less painful on your pocketbook. With planning and diligence, you can significantly increase the amount of money that stays in your bank account.
We are not certified tax lawyers or accountants, so take what follows with a heap of salt, consult appropriate people before you do anything big, and don’t blame us if you get in trouble for anything you do. Also, this advice applies to the United States. If you know some tricks for your country, we’d love to hear them in the comments.
Contractors can do all their work as a person. The company to whom you contract will get your SSN, then submit a 1099 form to the IRS that says “We paid this person $N in this year.” This is easy, there’s very little paperwork, and lots of people do it. However, there are a lot of good reasons why you would be better off incorporating as an LLC and having all your work done through your own business. The biggest reasons are liability and debt. Essentially, if someone sues the LLC, the worst that can happen is you lose the business. Also, if the business runs up debt and then goes bankrupt, the owner doesn’t lose their personal assets. There are lots of caveats to this; if you have to personally cosign a bank loan, for example. Banks aren’t just going to give an LLC a pile of cash without a way to guarantee that they get repaid.
There is a term called “piercing the corporate veil,” which means that in some cases the courts can determine that the LLC is just a shell and you can be sued personally or have your assets seized. This is why it’s important to set up a separate bank account, business cards, a web site, and every other measure possible to show that the business really is a business.
The bottom line is that if you are doing work for someone, then you want to set up a corporation to protect yourself. Setting one up is easy. It’s done through your state’s office, which is usually the Secretary of State, and involves an online form and up to a couple hundred dollars to file (plus a yearly fee to renew). It can be done in an hour or less. Note that in California LLCs have to pay a yearly fee of $800, so if you’re a casual contractor, this is a steep fee. In other states it’s much less. Next you would go to the IRS web site and file for an EIN. This is an online form that takes approximately 3 minutes, and results in an email with your EIN, the number used to identify your business to the IRS.
Next, go to the bank and open up a business checking account. You’ll need the information about the LLC. Finally, buy your domain name, get business cards, and get in the habit of using your business email for all business.
Expenses are an extremely powerful tool in saving money on taxes. In the course of doing business, you take your income, subtract your expenses, and that’s your profit, which is taxed. If you can increase your expenses, then you have less profit that can be taxed. This includes rent for an office, communications (internet and cell phone), office supplies and equipment, travel for work, and a lot of other things that are important in your daily life as a contractor.
As I mentioned before, you should consider incorporating. If you are not incorporated you can still make deductions by filing your 1099 income, and unreported income on a Schedule C. Being incorporated covers more income than just 1099 and unreported work.
Individuals who are not incorporated and do not file a Schedule C may…