What Are the Tax Benefits of LLC vs Independent Contractor?

If you're running your own small business or working as a freelancer, understanding the tax benefits of LLC vs independent contractor status can save you thousands of dollars each year.

So, is there a tax difference between having an LLC and being a sole proprietor? Not really, unless you elect S Corporation tax status for your LLC, which can reduce your self-employment taxes through salary and distribution strategies.

What Is an Independent Contractor?

An independent contractor is someone who provides services to clients while maintaining control over how, when, and where they complete their work. You set your own schedule, use your own equipment, and typically work with multiple clients, not just one employer.

From a tax perspective, independent contractors are considered self-employed business owners.

This means you'll report your income and expenses on Schedule C when you file your tax return. Since you don't have an employer to split payroll taxes with you, you'll pay the full 15.3% self-employment tax rate on your business profits to cover Social Security and Medicare contributions.

Independent contractors don't have taxes automatically withheld from their payments, so you'll need to make quarterly estimated tax payments throughout the year. You can deduct legitimate business expenses like equipment, office supplies, travel costs, and professional services to reduce your taxable income.

What Is an LLC?

A Limited Liability Company (LLC) is a business entity that separates your personal assets from your business assets, and it comes with flexible tax options. You can choose how you want your LLC to be taxed.

By default, single-member LLCs are taxed the same way as independent contractors. You'll still file Schedule C and pay self-employment tax on your business profits.

However, LLCs can also elect different tax treatments. For example, you can choose to be taxed as an S Corporation, which allows you to potentially save on self-employment taxes by paying yourself a reasonable salary and taking additional profits as distributions.

Is There a Tax Difference Between Having an LLC and Being a Sole Proprietor?

There's no tax difference between operating as an LLC and working as an independent contractor (sole proprietor) if your LLC uses the default tax classification.

Both structures file Schedule C, pay the same income tax rates, and owe the full 15.3% self-employment tax on their business profits. The IRS treats single-member LLCs as "disregarded entities" for tax purposes, meaning they're taxed exactly like sole proprietorships.

BUT the tax landscape changes when you elect S Corp status for your LLC.

This election allows you to split your business income between salary (subject to payroll taxes) and distributions (not subject to self-employment tax). This payroll and distribution strategy can reduce your overall tax burden. That is the main tax benefit of LLC vs independent contractor.

What Are the Tax Benefits of LLC vs Independent Contractor?

Self-Employment Taxes

Both independent contractors and single-member LLCs pay 15.3% self-employment tax on their business profits. This tax covers your Social Security (12.4%) and Medicare (2.9%) contributions since you don't have an employer sharing these costs with you.

However, as an LLC owner, you can elect S Corporation tax status and potentially cut your self-employment tax bill.

Instead of paying 15.3% on all your profits, you'd pay yourself a reasonable salary through payroll (which is subject to payroll taxes) and take the remaining profits as distributions. Those distributions aren't hit with the self-employment tax.

For example, if your business makes $80,000 in profit, you might pay yourself a $50,000 salary and take $30,000 as distributions. You'd only pay self-employment tax on the $50,000 salary, saving you about $4,590 in taxes. Learn more about paying yourself as a business owner.

Tax Deductions

Independent contractors and LLCs can deduct the same business expenses when filing their taxes. You can write off equipment, software, office supplies, professional development courses, business travel, and home office expenses. These deductions lower both your income tax and self-employment tax.

Whether you're an independent contractor or run an LLC taxed as a sole proprietorship, you'll use Schedule C to report these deductions. The rules and limits are identical between the two structures.

LLCs that elect S Corporation status follow slightly different deduction rules. You might have additional opportunities for tax-advantaged benefits like health insurance premiums and retirement plan contributions, but you'll also need to navigate more complex tax regulations.

Is It Better to Have an LLC or Be an Independent Contractor?

It depends, but generally speaking, you're better off as an LLC.

If you're just starting out, operating as an independent contractor is usually the simpler choice. You'll have minimal paperwork and lower setup costs. However, as an independent contractor, your personal assets, like your home and savings, are at risk if someone sues your business.

An LLC creates a legal barrier between your business and personal assets, making it much harder for creditors or lawsuits to reach your personal wealth.

From a tax perspective, an LLC also gives you more options. You'll pay the same taxes as an independent contractor by default, but you can elect the S Corp status once you're earning enough to make the self-employment tax savings worthwhile. A tax professional can help you figure this out.

FAQs

Do Independent Contractors Pay More in Taxes?

Independent contractors and LLCs taxed as sole proprietorships pay the same amount in taxes. Both pay the 15.3% self-employment tax on their business profits plus regular income tax rates. The tax burden can change when an LLC elects S Corp status, which allows for potential self-employment tax savings through salary and distribution strategies. Independent contractors don't have this option and remain subject to the full self-employment tax on all their business income. In this case, independent contractors will often pay more in taxes than an LLC.

Is a Single Member LLC an Independent Contractor?

A single-member LLC owner isn't an independent contractor, but they're often taxed similarly to one. The IRS treats single-member LLCs as "disregarded entities," which means that your business income flows through to your personal tax return, the same way an independent contractor's income does. You'll file the same Schedule C form and pay the same self-employment taxes.

However, LLC owners have limited liability protection for their personal assets. Independent contractors operating as sole proprietors have no legal separation between their business and personal assets. This can be a big problem if you get sued or have business debts.

Is LLC Better Than Self-Employment for Taxes?

An LLC isn't automatically better than self-employment for taxes since single-member LLCs are taxed as sole proprietorships by default. You'll pay the same income tax rates and self-employment tax whether you operate as an LLC or independent contractor. The tax advantages of an LLC come from the option to elect S Corporation status, which can reduce self-employment taxes through salary and distribution strategies.

How Can an LLC Avoid Self-Employment Tax?

An LLC can reduce (but not completely avoid) self-employment tax by electing S Corporation status and implementing a salary-plus-distributions strategy. You'd pay yourself a reasonable salary subject to payroll taxes, then take additional profits as distributions that aren't subject to the 15.3% self-employment tax.

Keep in mind that the IRS requires the salary to be "reasonable" for your industry and role, so you can't pay yourself $2 and take everything else as distributions.

Get Guidance on Your Taxes

Just having organized records or choosing the right business structure isn't enough to save money on taxes. You may be making mistakes that prevent you from taking the full advantage of all the tax benefits potentially available to you, such as missing deductions and choosing improper tax elections.

At Desi Tax, we let nothing slip through the cracks so you can find clarity and keep more of what you earn. Learn more about our bookkeeping & tax preparation services!