Set up as an independent contractor with everything you need for legal, tax, and business operations. Covers business entity formation, tax obligations, contracts, invoicing, insurance, and managing the transition from employee to self-employed.
Choose between sole proprietorship and LLC based on your risk level and income
Sole proprietorship: the default when you start working independently. No registration needed (except a local business license in some cities, 25-100 USD). Simple taxes (Schedule C on your personal return). No liability protection. LLC: costs 50-500 USD to form depending on state, provides personal liability protection (your personal assets are shielded from business lawsuits), and looks more professional when invoicing clients. Recommended once you earn more than 10,000 USD annually or work with clients in industries where lawsuits are possible. Single-member LLCs are taxed the same as sole proprietorships unless you elect S-Corp status.
Get an EIN (Employer Identification Number) from the IRS for free
An EIN is like a Social Security number for your business. Apply online at irs.gov (takes 5 minutes, instant approval, completely free). You need an EIN to open a business bank account, file business taxes, and avoid giving clients your personal SSN on W-9 forms. Even sole proprietors should get an EIN. It replaces your SSN on all business tax documents, reducing identity theft risk. Your EIN is permanent and does not change even if you change your business structure later.
Open a dedicated business bank account and keep all business transactions separate
Open a free business checking account (Chase Business Complete, Mercury, Novo, or Relay). Deposit all client payments here. Pay all business expenses from here. Never mix personal and business funds. This separation is critical for tax deductions (if audited, mixed accounts make it nearly impossible to prove business expenses), liability protection (commingling funds can pierce your LLC's liability shield), and financial clarity (you always know your business's true profitability). Most business checking accounts are free with no minimum balance.
Tax Obligations
Set aside 25-30% of every payment for self-employment and income taxes
As an independent contractor, you pay self-employment tax (15.3%: 12.4% Social Security plus 2.9% Medicare) on top of federal income tax (10-37% depending on bracket). No employer withholds taxes for you. Total tax burden ranges from 25-40% of net income depending on your tax bracket and state. Open a separate high-yield savings account (Ally, Marcus: 4-5% APY) and transfer 25-30% of every client payment immediately. This money is not yours to spend. Treat it as if it does not exist until quarterly tax payments are due.
Pay quarterly estimated taxes on the IRS schedule to avoid penalties
Quarterly estimated tax deadlines: April 15, June 15, September 15, January 15. Use IRS Form 1040-ES to calculate payments (or use QuickBooks Self-Employed which calculates automatically). The safe harbor rule: pay at least 100% of last year's total tax liability in quarterly installments (110% if your AGI exceeded 150,000 USD) to avoid underpayment penalties. For your first year as a contractor, estimate based on projected annual income divided by 4. State estimated taxes are separate and due on similar schedules. Underpayment penalties are typically 3-8% annualized.
Track all business expenses and deductions throughout the year
Common deductions: home office (5 USD per square foot up to 300 sq ft, or actual percentage of home costs), internet and phone (business percentage), computer and equipment, software subscriptions (Adobe, Zoom, accounting software), professional development (courses, conferences, books), business travel (mileage at 0.67 USD per mile, flights, hotels), health insurance premiums (100% deductible if self-employed), and meals with clients (50% deductible). Use an app (Keeper, Everlance, or QuickBooks) to track expenses in real time. Retroactive receipt-hunting at tax time is stressful and misses deductions.
Contracts and Invoicing
Use a standard independent contractor agreement for every client engagement
Essential contract clauses: scope of work (detailed description of deliverables), payment terms (rate, invoicing schedule, payment due date, late fees), independent contractor status (confirming you are not an employee), intellectual property (who owns the work product), confidentiality (protecting client's proprietary information), termination (notice period, typically 14-30 days), and limitation of liability. Template sources: Bonsai (19 USD per month, includes contracts and invoicing), AND CO by Fiverr (free basic contracts), or have a lawyer review a template once (300-500 USD). Never begin work without a signed contract.
Set up professional invoicing with clear payment terms
Invoice essentials: your business name and EIN (not SSN), client name and address, invoice number (sequential), date issued, payment due date (Net 15 or Net 30), detailed description of work performed, hours or project milestones, amount due, and payment methods accepted. Invoice tools: Wave (free), FreshBooks (17 USD per month), or QuickBooks (15-30 USD per month). Send invoices on the same day each month for retainer clients. For project work, invoice at agreed milestones. Include a late payment clause (1.5% per month) in both your contract and invoices.
Insurance and Benefits
Get health insurance through the ACA marketplace, spouse's plan, or a professional association
Options ranked by typical cost: spouse or partner's employer plan (often cheapest if available), ACA marketplace plan (HealthCare.gov, premiums vary by income and location, subsidies available for incomes below 400% of federal poverty level), professional association group plans (Freelancers Union, trade associations), health sharing ministries (Medishare, Samaritan: 200-500 USD per month, not technically insurance), and short-term health plans (cheaper but limited coverage). Self-employed individuals can deduct 100% of health insurance premiums on their tax return, reducing the effective cost. Budget 300-800 USD per month for individual coverage.
Set up your own retirement accounts: SEP-IRA or Solo 401(k)
As a contractor, no employer contributes to your retirement. Options: SEP-IRA (contribute up to 25% of net self-employment income, max 69,000 USD in 2024, easy to set up through Fidelity, Vanguard, or Schwab), Solo 401(k) (contribute up to 23,000 USD as employee plus 25% of net income as employer, max 69,000 USD total, allows Roth contributions), or traditional and Roth IRA (7,000 USD max, 8,000 if over 50). SEP-IRA is simplest for most contractors. Solo 401(k) is better if you want to maximize contributions or use Roth options. Contributions are tax-deductible, reducing your current year tax bill. This guide is informational only, not financial or legal advice.
Frequently Asked Questions
What is the difference between an independent contractor and an employee?
Independent contractors control how, when, and where they work. They use their own tools, set their own schedules, can work for multiple clients, and are responsible for their own taxes, insurance, and benefits. Employees work under the direction and control of an employer, use company equipment, follow set schedules, and receive benefits, tax withholding, and employment protections. The IRS uses a multi-factor test considering behavioral control, financial control, and relationship type. Misclassification (treating an employee as a contractor to avoid taxes and benefits) is illegal and carries penalties for the hiring company.
How much should I charge as an independent contractor?
A common formula: take your desired annual salary, add 30% for self-employment taxes and benefits (health insurance, retirement, paid time off), then divide by 1,000-1,200 billable hours per year. Example: 100,000 USD salary target plus 30,000 USD for taxes and benefits equals 130,000 USD divided by 1,100 hours equals 118 USD per hour. Round to 120 USD per hour. This ensures your take-home pay matches what you would earn as an employee after accounting for the benefits an employer would have provided. Research market rates for your industry on Glassdoor and through peer networks to validate your pricing.
Do I need to form an LLC to work as an independent contractor?
No, you can operate as a sole proprietor with no formal registration. However, an LLC is recommended once your annual income exceeds 10,000 USD or when you work with clients in litigious industries. An LLC costs 50-500 USD to form and provides personal liability protection (your house, car, and savings are protected from business-related lawsuits). It also looks more professional on contracts and invoices. Consult with an accountant about whether an S-Corp election (available for LLCs) would save you money on self-employment taxes once income exceeds 80,000-100,000 USD.
What happens at tax time for independent contractors?
You file your regular Form 1040 with an additional Schedule C (Profit or Loss from Business) reporting all business income and deductible expenses. You also file Schedule SE (Self-Employment Tax) calculating the 15.3% self-employment tax on net earnings. If you paid quarterly estimated taxes throughout the year, those payments are credited against your total tax liability. You will receive a 1099-NEC from each client who paid you 600 USD or more during the year. Keep all receipts and records for 3-7 years. Most contractors benefit from hiring a CPA or tax professional (200-500 USD) rather than self-filing, as they catch deductions you might miss.