Minimal Requirements for Working as an Independent Contractor
Many independent contractors and service providers 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 a few governmental rules, even if you work only a few hours per week for one or two clients.
At a minimum, do these first three things when you're first starting out as an independent contractor:
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It's a good idea to choose a business name that you can use on your invoices and business cards; to many potential clients, using a business name rather than your own appears more professional.
Depending on the name you choose, you may or may not 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.
Skipping This Requirement
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.
If you don't use your full name, however, you should register it, for a couple of reasons. 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.
How to Register Your Fictitious Business Name
In most states, including California, you'll register your fictitious business name at the county level, with your county clerk. As a result, each county in your state may 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 get a general license. This license is sometimes called a business license, sometimes called a tax registration certificate. A business license 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 business license in the city where you live, even if none of your clients are in that city. Contact your city clerk for a business license application.
Skipping This Requirement
Some independent contractors skip the business license, figuring they can stay under the local government's radar. But consider this: Business licenses are inexpensive -- usually only $30-$50 -- but the penalties for operating without a license can be in the hundreds of dollars. In addition, in some locales it is a misdemeanor to violate the city ordinances by operating without a business license.
Getting a Vocational License
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 Obtaining Licenses and Permits.
Unlike employees, who have income taxes and self-employment 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 on 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 or $4,000 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.
Skipping This Requirement
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 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 Hobby Business Tax Rules.
How to Register With the IRS as an Independent Contractor
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.
Above are the three basic steps you need to take before you start providing services as an independent contractor. Once you get started, you will be running a legitimate business (a sole proprietorship, if don't have a business partner and don't form a corporation or a limited liability company).
As a small business owner, you should learn the basics of bookkeeping and record keeping, and you may also want to take small marketing steps such as listing your business in the Yellow Pages. For more information, see Bookkeeping and Accounting and Marketing.
