How To Set Up an Independent Contractor Business

What to Do First To Become an Independent Contractor

Independent Contractor working on mechanical drawing in their shop.
••• Thomas Barwick / Getty Images

Maybe you have taken a job as a contract worker within the company where you used to be an employee. Or maybe you were hired as an independent contractor or freelancer to do work for a company. In any case, as a freelancer or independent contractor, you are not an employee. You are self-employed. Being an independent contractor seems easy, right? You just go to work and collect the money. But there are a few easy steps to making your business real.

Am I an Independent Contractor?

You are an independent contractor if you are working for someone not as an employee. It also means you can work for anyone you want, and work for several different people or businesses at the same time. The people hiring you and paying you only can control the results of your work, not how it will be done or what will be done.

The Benefit of Setting up a Business Entity

If you set up a business entity such as a sole proprietorship, you can deduct legitimate business expenses to minimize your tax bill. You can also use the deductions to minimize your profit and lessen your self-employment tax burden.

A sole proprietorship is the basic default business type for tax purposes. You don't have to do anything to register your business, just start using a Schedule C to report your business income with your personal tax return.

You can use your business entity to purchase insurance and take the deductions for this expense, again minimizing your tax bill. Setting up an entity minimizes the chance that the IRS will say your business is just a hobby or deny your deductions.

You can set up simply as a sole proprietor, or you can go the next step and register as a limited liability company or other entity. In any case, taking your business to the next level by establishing a business entity separate from your personal finances is worth your time and trouble.

First Steps to Becoming an Independent Contractor

Now that we have that out of the way let's talk about starting your independent contractor business. First, understand that there are a lot of things you DON'T NEED to do when starting a business, like having employees and registering with your state. But there are three things you should do to start off right: 

Select and Register a Business Name

When you have selected a business name, don't rush out and buy business cards and stationery yet. First, check to be sure no one else is using that name. You may need to file a fictitious name (trade name or d/b/a) statement if your business name is different from the name of your company.

Once you have a business name, you can get a business location and begin to create all the marketing and promotion items you'll need, like a website, business cards, and advertising brochures.

Get a Business Checking Account

Getting a business checking account will help establish that separate business entity, so it is clear to the IRS - and anyone else who cares - that you and your business are separate entities. 

Once you have a business checking account, you can put money in as your own investment and begin paying for all the things you need to get started in your business. And of course, if you have money coming in you can put it into your business bank account to pay for startup costs. It's best to use a business account instead of a personal account so you don't get the payments and income confused. 

Set up a Simple Business Recordkeeping System

Capture the information you need to support your use of legitimate business deductions. Making sure you keep track of business income and expenses will help you know how your business is doing, and you will be able to deduct those expenses from your income at tax time. 

You should create a simple budget to see what you'll need to spend to get started. Then, keeping records also means you can tell how your business is doing, by preparing and reviewing your business financial statements each month, including a profit and loss statement and balance sheet.

Your business name and address can also be used to apply for an Employer ID Number (for tax purposes) for your business. The Employer ID is necessary for most types of businesses, even if they don't have employees. 

Pay and Taxes as an Independent Contractor

As an independent contractor, you don't get a paycheck, but instead, you will get paid in a check or online, just as any other business or vendor.

Notice that there are no withholdings from these checks for federal or state income and Social Security and Medicare tax. You must still pay these taxes but in a different way.

You must still pay these taxes based on your annual income as an independent contractor:

The IRS won't allow you to wait until the end of the year to pay these taxes, so you must make quarterly estimated tax payments.

At the end of each year is in the form of a 1099-NEC, which you must pay taxes on.

You will also have no one to pay your insurance (health insurance, liability protection), so you will have to pay it yourself or do without.

To help you better manage your bookkeeping and tax calculations, here are the best accounting apps for independent contractors.