Employer of Record & PEO — 10 min
Although many freelance workers relish the freedom associated with working as independent contractors, some struggle to handle the extra responsibilities.
There are a lot of work aspects you have to figure out when you become an independent contractor.
How does business licensing work? How do you handle your taxes? What’s a business entity, and why does the bank keep asking you if you’ve registered one?
This article answers all these questions and more by breaking down the process of how to become an independent contractor into six simple steps. We also explore the benefits and potential drawbacks of working as an independent contractor so you can make an informed decision about the direction in which to take your business.
It’s estimated that around 15% of all workers are independent contractors. However, many freelancers don’t know whether they’re considered a business — especially if they’re new to the freelance world.
While there isn’t a standard “test” for independent contractor status, you can use the guidelines below to help determine which category you fall into.
The exact definition of employee vs. independent contractor will vary depending on where you’re based. A general rule of thumb, however, is that a permanent employee is a worker hired on a contractual basis, while an independent contractor is a self-employed worker hired to do a specific task or project.
If you’re an independent contractor, there is no legal permanent employment relationship between you and the business that hires you — even though you might continue to work together in the future.
It’s important to be clear about your employment status. If a company misclassifies an employee as a contractor, or vice versa, they can face heavy fines, harsh penalties, and even loss of intellectual property.
The consequences of misclassification make many companies hesitant to work with independent contractors.
Becoming an independent contractor can feel overwhelming, but it doesn’t have to be. Follow the six steps below, and you’ll be on the path to a rewarding and lucrative career.
This step is less important when you first start out as an independent contractor, as long as you keep records of your transactions for future reference.
When you start working as a contractor, you are a sole proprietor — the exclusive owner of your unregistered business. In a sole proprietorship, there is no legal distinction between you and your business entity, which means your business assets are considered personal assets.
What about business taxes? As a sole proprietor, you’re only responsible for paying income tax on your business profits each year, so you just need to file one tax return.
As you begin to take on more clients and work, you can choose to adopt one of the following business structures:
One-person limited liability company (LLC): To form a one-person LLC, you need to be the only owner and worker in the business. You can’t have employees. And, because you need to register your business to form a one-person LLC, your personal assets and business assets are separated. In this case, you’re responsible for handling your business taxes separately from your personal taxes.
Incorporation: If you plan to hire employees or sell products (as opposed to providing a service), consider forming a corporation. Incorporating may involve selecting a board of directors to help you make important decisions about the business as it grows.
Partnership: If you provide professional services, such as dentistry, law, or accounting, and you have the potential to work with another professional, consider forming a partnership. A partnership agreement means your profits, losses, and taxes will be shared between partners.
Your business structure outlines the way you pay taxes and accept liabilities. If you don’t choose a specific business structure, you’ll be considered a sole proprietor as long as you work alone.
If you hire employees or work with another professional without registering your business, you can face penalties and legal consequences. The nature of these consequences depends on the laws of the country you’re working from.
Now it’s time for the fun part — deciding on a name for your business. Choose a name that’s unlikely to change in the future to ensure consistency for your clients. It’s also good to choose a name that’s unique to your business.
In most areas, you need to register with a fictitious business name if the business name doesn’t include your full legal name. To do this, you’ll need to file a fictitious name statement. Registering your business name will prevent other companies from using the same name.
If your full name (as the legal owner of your business) is included in your business name (such as “Emma Eyre Accounting Services”), then you don’t need to register the name.
If you don’t use your legal name and fail to register your business name, you could face the following consequences:
You can’t enforce contracts signed under that name
Most banks won’t allow you to open an account under that name until it’s registered
Someone else could register as a business using your business name
A tax registration certificate confirms your business is registered for tax purposes. Most cities require every business to register with the local tax collector. Some, however, only require registration if you earn above a certain amount each year.
More than 40% of independent workers expect continuous economic growth over the next five years. If you aren’t already registered to pay business taxes, it won’t be long before you’re earning enough to need a tax certificate.
If you earn enough to be liable for business taxes and don’t have a tax registration certificate, you could face penalties and fines for operating a business without the appropriate documents. In some areas, it’s considered a misdemeanor to operate a business without a tax registration certificate.
Depending on the service you provide, you may need a professional or vocational license to operate your business legally. Licensing is essential for auto mechanics, real estate agents, electricians, hair stylists, and other professions.
To determine if you need a license to operate your intended business, ask your trade association or local government officials.
If you operate your business without the appropriate vocational license, it can be considered fraudulent activity. Your local laws may force you to stop doing business. You also might have to deal with fines, penalties, or criminal charges.
If you were employed full-time, your employer would handle estimated tax payments for you by withholding a certain percentage of your income each month. As an independent contractor, you handle these payments yourself.
You’ll want to open a business bank account to make this process easier. Separating your business and personal finances helps you manage your finances, assess your business’s success, and pay the correct amount of tax. This is because you can keep transactions for your business income and expenses in one separate account.
Having a business checking account also helps establish your business’ credibility with clients, vendors, and suppliers.
If you don’t separate your business finances from your personal finances, taxes can get murky. Separating the two helps you avoid making calculation errors or missing tax payments.
If you miss a tax payment, you may have to pay penalties and interest on back taxes, costing you unnecessary income.
Once you’ve opened your business bank account, you can set yourself up to get paid quickly and easily. You’ll need a contract agreement template, an invoice template, and a payment mechanism for clients to pay you.
Remote makes it easy to manage payments as an independent contractor. You can use the platform to:
Create recurring invoices
Log your business expenses
Manage business and client documentation
Localize client contract agreements to remain compliant
Get paid in your local currency
In 2022, there were around 31.9 million people working as independent contractors in the United States alone. When you look at the benefits of freelance work, it isn’t difficult to understand why working for oneself is becoming increasingly popular.
Here are the main benefits of working as an independent contractor:
Freedom and flexibility. According to 83% of freelancers, being your own boss is the best part of working as an independent contractor. You have the authority to set your own hours and can design your calendar to suit your lifestyle.
Greater variety of clients and projects. Independent contractors can be as selective about their work as they choose. You have the power to prioritize and focus on projects that excite you.
Pro tip: Using a contractor management platform like Remote helps independent contractors collaborate with clients around the world through a simple setup and payment process. Remote makes it easy for any independent contractor to get paid by both domestic and international clients.
Improved work-life balance. Because you set your hours and choose the projects you take on, it’s easier to maintain a healthy work-life balance than working as an employee. And because you don’t have colleagues relying on you, you have greater flexibility when it comes to scheduling and taking time off.
Financial control of your business. As the owner of your business, you get to keep all the profits from your work. You also get to decide how much money you want to invest back in the business.
Lucrative career. Working as an independent contractor can be highly lucrative. As you gain experience, you are able to set higher fees and choose more profitable clients to boost your income.
Access to tax deductions. As an independent contractor you can claim tax deductions for business expenses, such as driving costs or depreciation on business purchases.
Before you make freelance work your main source of income, make an informed decision by having a realistic view of working as an independent contractor.
There are a number of valid concerns many people have before taking the plunge into freelance work. Fortunately, you can stay on top by being prepared for the below common concerns, and still create a career that works for you.
More responsibility. If business goes badly, you bear the brunt of any losses. Still, it’s easy for you to monitor your finances and catch issues ahead of time because you’re the only person involved in each project.
No employee benefits. Benefits like health insurance are some of the main incentives of being a full-time employee. However, as an independent contractor you have complete control over how much you invest in these areas.
Liable for self-employment tax. Being liable for self-employment tax means you pay for your own social security, retirement, and things like Medicare taxes in the United States or National Insurance Contributions in the United Kingdom. However, this means you also have the opportunity to decide how much you want to invest in these areas.
Inconsistent income. When you start working as an independent contractor, your income can vary significantly from month to month. While this can be difficult to manage, you can still lead a lucrative career. This is because you have complete control over your rates, your clients, and the type of work you do. Over time, you can build a stable business even as an independent contractor.
Working for yourself is not always easy, but it comes with the freedom and flexibility to manage your own business. You can reap the professional and financial rewards of your hard work and dedication as an independent contractor.
Remote makes it easy for independent contractors to succeed by helping companies onboard, manage, and pay independent contractors in 200+ countries. We help businesses manage local laws, benefits, and tax compliance requirements to facilitate smooth global expansion. This also creates an enjoyable experience for independent contractors working through Remote.
To find out more, read our full international contractor management guide on getting set up as a contractor.
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