Business

Do Independent Contractors Need an LLC? Pros, Cons, and Protection

Panna Kemenes

09.03.26

Read time 7 minutes

Many entrepreneurs may wonder whether they should go to the trouble of filing an LLC or continue operating as a sole proprietor.

LLCs are a very common choice for many individuals, as they can provide additional tax benefits and are easy to register. There are currently over 21 million LLCs in the United States.¹

This article will explain some of the financial and legal benefits of forming an LLC, and help you decide whether setting up an LLC is the best move for you.

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Does an Independent Contractor Need an LLC?

Independent contractors do not need to form an LLC, but many choose to do so for a variety of reasons. Forming an LLC provides the individual with limited liability protection, tax benefits, and increased credibility.

Legal Protection (Limited Liability)

Many solo entrepreneurs choose to form an LLC for the legal benefits. When you form an LLC, you can’t be personally sued or held liable for the company’s debts.³ This move can be very helpful if your business faces financial issues or is sued by another party.

Tax Implications (Pass-Through Taxation vs. S-Corp Election)

Forming an LLC can also provide you with more tax flexibility, ultimately resulting in options to lower your tax bill. For example, companies can form an S corporation to lower some of the higher Social Security and Medicare taxes that self-employed individuals pay.⁴

Credibility and Professionalism

One of the other intangible benefits of forming an LLC is the boost in your company’s image. For many people, forming an LLC is an increased sign of credibility. Forming an LLC may help your business more easily win the trust of new clients.

Ease of Formation and Maintenance

Filing an LLC can provide many benefits, and the process is very easy. In some states, it only takes several hours to form an LLC.⁵ It is also cheap to file an LLC, with some states only charging $50.⁶ To file an LLC, you will need to complete several documents, pay a state fee, and then apply for an Employer Identification Number (EIN) with the IRS.

After you have created an LLC, you can apply for any necessary permits that the state requires. Once your LLC is formed, you will have to complete paperwork on an annual basis, which varies from state to state.

Personal Assets Protection

One of the major benefits of starting an LLC is that it can help you protect your personal assets. Individuals who operate as sole proprietors risk having their personal assets, such as their home or car, taken away if their business runs into excessive debt or legal issues. Filing an LLC is a simple step you can take to protect your assets from any issues your business may face.

What is the Difference Between an Independent Contractor and an LLC?

Individuals may choose to operate as an independent contractor or as an LLC. States classify a single-member LLC as a disregarded entity, which means the individual is taxed the same as a sole proprietor. Individuals who elect to be taxed as an S-corporation have more freedom in terms of taxation.

One of the other major differences is the paperwork and ongoing filing requirements. LLCs have to complete more paperwork initially and on an annual basis. On the other hand, sole proprietors do not need to file these documents unless they want to operate under a trade name (DBA).

When Could an LLC Be Beneficial for a Contractor?

There are many cases when it is highly beneficial for a contractor to form an LLC to help protect and grow their business. Below are some special cases that companies should consider, which may make it ideal for them to form an LLC.

High-Risk Industries

Small businesses have been particularly hit hard by lawsuits in recent years. According to the US Chamber of Commerce, the total commercial tort cost for a company with revenue below $1 million is $35 per $1,000 in revenue.⁸ Small businesses in high-risk areas like retail, construction, tech, and food services should be especially cautious of this fact. Forming an LLC and purchasing the appropriate insurance products can help your company more effectively navigate these risks.

Significant Business Expenses

As your business grows, it becomes more crucial to find ways to lower expenses and legally minimize your tax bill. Many companies that grow face rising costs, and often choose to form an LLC for additional tax savings options. S corporations can offer companies tax savings, as they can pass profits to the owners’ personal tax returns.

In many cases, the extra cost of filing an LLC and maintaining it is negligible relative to the tax savings and legal protection.

Plans for Growth and Expansion

Forming an LLC may also be a natural step as your business expands. Apart from offering potential tax savings, forming an LLC can also boost your credibility and make it easier to find investors.

Desire for Separate Business Finances

Many sole proprietors face challenges during tax season when they have to separate personal and business expenses. Setting up an LLC is a convenient way to organize your finances, ensure compliance, and expedite the tax filing process.

What Are the Disadvantages of an LLC for an Independent Contractor?

Some independent contractors may prefer not to file an LLC, as it may create headaches for them and carry many disadvantages. One of the main disadvantages of filing an LLC is the higher cost of filing and maintaining the entity. Any missed deadlines can result in fines and even administrative dissolution of the entity. Individuals who merely operate as sole proprietors do not have to worry about filing and updating these documents.

What Are the Tax Benefits of an LLC for Independent Contractors?

The main benefit of filing an LLC and operating as an S corporation is the freedom to choose how you are taxed. Contractors who file an LLC can pay themselves a reasonable salary, allowing them to partially offset some of the typically higher self-employment taxes. Contractors who file an LLC may also be able to more easily manage and track their business expenses.

How Do Independent Contractors Pay Taxes with an LLC?

When an independent contractor forms an LLC, it is automatically classified as a disregarded entity. Under this structure, the contractor pays taxes in the same manner as a sole proprietor. The contractor needs to file Form 2523 to be treated as an S corporation and enjoy potential tax savings benefits.

⚠️ It is always best to consult an official tax advisor or accountant when it comes to business taxes.

What Alternatives to an LLC to Consider as a Contractor

Contractors who do not want to file an LLC can choose from some of the following options.

Sole Proprietorship

The simplest step is to do nothing and automatically be classified as a sole proprietor. Contractors who change their mind later also have the option to file an LLC, and to potentially elect to be treated as an S corporation.

General Partnership

Contractors who have a business partner can choose to form a partnership. A general partnership10 is the simplest option, which does not require any formal documents. However, you would be liable for the debt of your partner under this structure.

Steps to Form an LLC as a Contractor

If your company wants to set up an LLC, you can complete the process by following these steps.

Choose a Business Name

One of the most important steps is ensuring that your business name is available in the state. Before you file your LLC, you can check the Secretary of State website to make sure your name is available. Moreover, it is also worthwhile to check if the business name is used in another state. Your business could run into trademark issues if a business in another state is already using the same name.

Need some help choosing a business name? Try the free business name generator from Wise Business.

Appoint a Registered Agent

Every business is legally required to appoint a registered agent. While companies are allowed to serve as their own registered agent, many choose to pay for a registered agent service. These services can help you manage incoming mail and also keep your personal address private.

File Articles of Organization

Companies also need to file Articles of Organization, a type of legal document that contains information about the LLC members and their responsibilities. When you complete this document, you will need to include information such as your business address, company members, ownership information, and the responsibilities of each member.¹²

Create an Operating Agreement

It is also very important for your business to create an operating agreement when you create an LLC. Although not every state requires companies to do this, it is still a very important document. The operating agreement contains key information like member ownership, voting rights, management duties, distribution information, and buyout rules.

Obtain Necessary Licenses and Permits

Once your LLC is formed, it is also important for you to research the licensing requirements at the state, city, and county levels. Depending on your business, you may be required to obtain a license and pay an annual fee to avoid fines.

Receive and Manage International Payments with Wise Business

Does your business make and receive international payments? Wise Business can simplify the process and help avoid unnecessary fees, for independent contractors and LLCs alike.

Wise is not a bank, but a Money Services Business (MSB) provider and a smart alternative to banks. The Wise Business account is designed with international business in mind, and makes it easy to send, hold, and manage business funds in multiple currencies. You can get major currency account details for a one-off fee to receive overseas payments like a local. You can also send money to 140+ countries.

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Sources

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