How Much Do Independent Contractors Pay In Taxes Compared To Other Entities?

Being an independent contractor is how most self-employed individuals start their journey. But what happens if your business starts growing? Suddenly, you need to hire more people or find yourself needing more financial help to reach your goals.

In that case, you might consider changing your business structure to another type of entity. This is a big decision, so you should definitely get professional help before committing to the change. Whether you're thinking about becoming an LLC, an S corporation or a C Corp, it's essential to understand the tax implications of this move.

Why would independent contractors change their business entity?  

As an independent contractor, you're essentially a one-person show. While this provides flexibility, it may not be the most tax-efficient structure as your business grows. Switching to a different business entity could offer some more advantages:

Ease in raising capital

Switching from an independent contractor to an LLC or an S Corp can boost the credibility of your business. These entities need to be registered with the state and require a lot more legal procedures to be established.

This can show your clients that you’re a legitimate business operation and are serious about your offerings. It is also much easier to find investors as an LLC, S Corps or a partnership as there's a lot more protection against liability, so investors won’t be as hesitant to find you.

Tax benefits

Independent contractors are responsible for paying their own income taxes. Switching to a different business entity can often allow you to reduce the amount subject to self-employment taxes. If you switch to an S corporation, for example, you can pay yourself a reasonable salary and claim the leftover business income as dividends, which are not subject to self-employment tax.

Increased liability protection

Limited liability protection is one of the most common reasons independent contractors move to a different business entity like C Corps or LLCs. Separating personal assets from business assets can protect owners from using their own property or money to pay for business debts.

Tax implications of switching from an independent contractor to another entity

Let’s talk about how changing your business entities can affect your tax situation.

Change in tax filing

Usually, independent contractors report their income and deductions on Schedule C. But entities like partnerships report their business income on Schedule K-1 and also have a different filing deadline to independent contractors (March 15).

Independent contractors are also taxed as “pass-through” entities, meaning they only pay personal taxes. Certain LLCs and S Corps are pass-through entities, but C Corps are not. They have to pay both corporate tax and personal taxes.

If you’ve newly switched entities, FlyFin can help ease you into the process by handling all your taxes. Expert CPAs offer unlimited preparation and filing support while A.I. easily finds every deduction, maximizing your savings.

More tax deductions

Switching to a different business entity can open the door to claiming a lot more self-employed tax deductions. LLCs, for example, can write off insurance, office rent and business startup costs from their taxes. You can also deduct any retirement contributions as a business expense if you have any employees. An LLC tax calculator can help you find more of these deductions.

Paying estimated taxes

Calculating estimated taxes as an independent contractor is fairly straightforward. You just estimate your income for the year, calculate your taxes and make quarterly payments to the IRS using Form 1040-ES.

LLCs, partnerships, S Corps and C Corps all have to make estimated tax payments, too. However, S Corps, multi-member LLCs and C Corps all have to use Form 1120-W to make these payments.

Tax planning is also super important when switching over to a different entity. Usually, this means increased income and business expenses, so setting aside enough money to cover estimated taxes should be one of your biggest priorities.