If you are a sole proprietor working as an independent contractor, there are lots of advantages to setting up your business as an LLC. In fact, we just covered that in another post (Sole Proprietor vs Single Member, LLC) worth checking out if you’re considering such a move.
But what do you do if you’re a Single Member LLC (SMLLC) doing freelance work and you need to hire other independent contractors to help you with a project?
Can an LLC have independent contractors? If so, how do you handle it and not get into a mess with your taxes or finances?
We think you deserve to be able to grow your business with confidence, not confusion. So we’ll cover this question and more right here today.
Can an LLC Have Independent Contractors?
When you form your business as an LLC (even if it is just you operating as a Single Member LLC), you create an entity that is completely separate from you personally. The assets of your business and your personal assets no longer mix. That’s the beauty of having an LLC!
Prior to establishing an LLC, you were legally considered a sole proprietor. As such, your personal assets were directly connected to your business along with any debts or liabilities it was responsible for.
An LLC can function as either a corporation, partnership, or sole proprietorship. LLC members (or owners) are considered self-employed by the IRS. However, LLCs can hire employees or independent contractors…just like any other business.
The IRS has pretty strict standards for determining whether or not a worker hired by a company is considered an employee or a contractor. They have a helpful page titled “Independent Contractor (Self-Employed) or Employee?” that you need to take a look at before hiring anyone to make sure you fully understand the differences they’re looking for.
We also did a post on “Why It Matters to Know the Difference Between Employee and Contractor” a while back that is also worth reading (even if you just want to see how Federal agents and Highway Patrol can work together).
It’s important to know the difference because it affects whether you, the business owner, are required to withhold payroll taxes or not. That can significantly impact your taxes at the end of the year. It can also come across as a form of tax evasion if the IRS has reason to believe that you are misclassifying employees in order to avoid paying such taxes! (Again, see the story above.)
How to Quickly Determine If Someone Is a Contractor or Employee
The IRS apples 3 “Common Law Rules” to help decide if a worker should be considered an employee or contractor:
- Behavioral – Are you able to tell the worker what to do and how to do it?
- Financial – Do you control when the worker gets paid? Do you supply the tools necessary for them to do their job?
- Relationship – Is there a written contract or job description? Does the worker receive benefits such as insurance, paid time off, etc.? Is the length of the relationship ongoing and undefined or limited to a specific project?
The State of Tennessee (where all of our branch offices are located) uses a variation on that test plus 20 other factors. A few of the points they list include:
- Instructions
- Training
- Supervision of other workers
- Regular hours
- Payment of Expenses
- Right to terminate
We recommend that all of our clients who operate businesses in Tennessee make sure they are familiar with all 20 employee vs contractor tests. If your company is elsewhere, be sure to know all of the local guidelines for your state as well as federal rules.
Independent Contractors and LLCs
The process for hiring independent contractors to work for your LLC is pretty straightforward:
1. You’ll need to create some sort of written agreement.
As nice as it sounds to be able to trust people like they did in the old days, don’t do business on a handshake alone. Anytime your company does business with an independent contractor, make sure you have a contract in writing. It doesn’t have to be anything fancy, but it does need to spell out clearly:
- The scope of the project they’re being hired to for
- How they will be paid
- Who is responsible for supplies and materials
- Protection clauses such as indemnity, confidentiality, termination, etc. (If any of this is overwhelming, don’t worry! Our business team can help walk you through it all.)
2. They need to fill out a Form W-9.
It’s a form that you need to provide them, but when they fill it out you will have a record of their Tax Identification Number (TIN). Their TIN could either be their Social Security Number (SSN) or Employer Identification Number (EIN). Plan to keep this form on file for at least 4 years in case any questions come up later.
3. You’ll need to give them a 1099-MISC or 1099-NEC.
If you pay an independent contractor more than $600, you are required to provide them with this form at the end of the year. This enables them to correctly pay taxes on revenue they receive from you. Give them a copy, keep one for your records (you’ll need it for the next step), and send one to the IRS.
4. You’ll need to send the IRS Form 1096.
Its official name is the “Annual Summary and Transmittal of U.S. Information Returns”, and its purpose is to give the Social Security Administration a single report showing all of the 1099 activity your company participated in that year. You’ll also send copies of each 1099-MISC you sent to contractors.
We Can Help You Become a Contract Work Limited Company
Our firm has been doing way more than taxes for the past 40 years. We’ve been helping business owners just like you set up and run companies efficiently and effectively so they can grow and achieve their dreams.
Our clients have learned to “expect more from your CPA”, and we’d love for you to do the same! Schedule a call today to learn more about how we can help you do business as an LLC working with independent contractors…and more!
