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How To Become an Independent Contractor
HOW TO BECOME AN INDEPENDENT CONTRACTOR
If you structure your job properly, you can turn
an employer into a client and end up getting more money
for doing the same job by becoming an independent
contractor. Your former employer no longer has to pay
your Social Security, unemployment compensation taxes,
or workman's compensation benefits. And he is free
from the bookkeeping headaches of calculating and
deducting Social Security and income taxes and
forwarding the money to the government, of processing
paperwork for your health insurance, and of providing
you with supplies.
You may be able to negotiate splitting some of
those savings with your boss when you go solo.
Don't dismiss this option as a wild-eyed dream
reserved for mavericks. Thousands of mainstream folks
do it each year. House painters, floor layers,
researchers, writers, custom seamstresses, management
experts, engineers, carpenters, electricians, insurance
claims processors, bookkeepers, and people from dozens
of other fields successfully turn to private
contracting -- at least in part as a means of reducing
taxes.
Independent contracting won't relieve you
completely of taxes. But you pay income tax only after
deducting all your business expenses, including some
personal and fringe benefit expenses. (More on this
later.)
In addition to income taxes, you pay Social
Security tax, in the form of "self-employment tax,"
which is about 2% or 3% less than the tax companies pay
for employees.
The IRS is well aware of the tax benefits of being
an independent contractor, so follow the rules. One
mistake, and the IRS may attack. The courts tend to
back up the IRS on this issue. You also cannot dodge
tax withholding by going out on your own. You must
estimate your income taxes for the coming year and send
a quarter of the estimated amount to the federal and
state government each calendar quarter.
The key to determining whether you are an employee
or a contractor is the degree of control you have over
your work. The more control you have, the more you
look like an independent contractor. The more your
boss can boss you around, the more you look like an
employee.
To appear independent -- at least to the IRS --
you have to control the number of hours you work and
when you work them. It also helps to get paid by the
product rather than by the hour. A true independent
contractor should also control everything about a job
except the result. Your client generally cannot
dictate how to reach that result. His only legitimate
concerns are the quality of your product and how long
it took you to do it.
Eventually -- but the sooner the better -- you'll
need to pick up more clients. If you work as an
employee for a number of years, then convert to
independent contractor status, you could be in trouble
if you still spend 90% of your time working for your
former boss. The IRS may view this as an employment
relationship. Try to line up small assignments with
other firms as soon as possible.
This may seem tough, but you'd be surprised how
many new independents get flooded with work.
Another sticky point with the IRS is office space.
You must have an office in your home or somewhere other
than on your former employer's business premises. Some
advisors say you should only have office space you pay
for if you want to look like an independent contractor.
Also, pay for your own office supplies and
equipment. Make sure you have basic supplies that make
you look like a business -- such as stationery and
business cards.
Put together a written contract covering all these
points. It can be as simple as a "letter of agreement"
between you and your new clients outlining the product
you will deliver, when it is due, and what your fee
will be. Having a contract doesn't seal your case, but
it creates a strong presumption in your favor. The IRS
will check the facts to see if the parties are abiding
by the contract.
Under new tax laws, the IRS looks more closely at
these arrangements than in the past. If you plan to
work as an independent contractor for just one company,
it's a good idea to talk to a professional tax advisor.
A change to consultant with your current employer
will allow you to negotiate your benefits to a dollar
value included in your fees. Take into account the
value of benefits such as sick leave, employee
discounts, and health, disability, and life insurance.
As an unincorporated business, you must pay for these
items yourself, and for the most part, they are not
deductible on your tax return.
The self-employment Social Security tax of 12.3%
is a big bite and is not deductible for you or the
business. Balance this with the benefits. If you
incorporate -- an option we'll get to later -- you can
deduct some of these expenses. Keep in mind too that
you may be able to get your new client to boost your
fee to cover these items.
If you don't incorporate, you may be able to take
the lucrative home office deduction. Whether you
incorporate or not, you can deduct many otherwise
personal expenses.
If you're not sure about breaking away from the
security of your job right away, start with a sideline
business in your spare time. You can keep your present
job while starting on the road to self-employment and
make the full-time jump later, if ever.
The easiest way to do this is to make a business
out of something that you love to do and are spending
time and money doing anyway. Whenever you can convert
a personal expense into a business expense, you can
save tax dollars. Even if you're not realizing profit
on it you may as well gain the tax advantage. There
are countless sideline business possibilities: real
estate, accounting, free-lance writing, graphic art,
auto repair, teaching night school, and tutoring. If
you make crafts for friends and relatives, start
selling them at flea markets and fairs. Look for
distant craft shows, combine the business with your
vacations and write off not only the craft supplies
(which you were buying anyway) but also part of your
vacations (which you were taking anyway).
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