It may sound odd, but a single individual can register to become a single-person corporation. By incorporating one’s business, the individual assumes the role of CEO, executive assistant, and manager – to name a few – along with the mandatory role of the company’s shareholder.
A sole proprietorship (SP), single-member limited liability company (LLC), and single-person corporation are all examples of one-owner businesses.
The distinction between a company and a corporation is incorporation. Incorporation is the process of constituting a business by creating a legal entity that separates an owner’s personal affairs and finances from those of their business. A sole proprietorship is the only type of business entity that is not incorporated.
Interestingly, an unincorporated sole proprietorship shares many similarities with an incorporated single-member LLC. Although their respective business structures may differ regarding personal liability, they share the same responsibility of paying self-employment taxes. Meeting the criteria of self-employment taxes makes a sole proprietorship and a single-member LLC the only two types of business entities that are independent contracting businesses.
Other common business structures include:
- A partnership
- An LLC (in addition to a single-member LLC, there are multi-member LLCs)
- A corporation (S corp, C corp, B corp, or non-profit)
Depending on how some of these entities set themselves up, they can be a one-person operation that is not an independent contracting business.
In this guide, we’ll look at the different types of one-owner businesses and how they operate. We’ll also explore how independent contractor taxes are paid in other countries, diving deeper into the US market for those interested in engaging independent contractors in the United States.
Single-Member LLC vs. Sole Proprietorship
Single-Member LLC vs. Sole Proprietorship: which option is better for you? Before looking at the benefits of hiring a single-member LLC or a sole proprietor, let’s examine the similarities of these independent contractor entities alongside single-person corporations. For clarity, “owner” refers to a one-person business entity run by one individual.
Business Entity
- Sole Proprietorship (SP): Company
- Single-Member LLC: Company (a single-member LLC that does not elect itself as an S or C corp, remains as a company.)
- Single-Person Corporation: Corporation (a single-member LLC can elect to be an S or a C corp. This makes it a corporation.)
Legal Status
- Sole Proprietorship (SP): Unincorporated
- Single-Member LLC: Incorporated
- Single-Person Corporation: Incorporated
Number of Workers
- Sole Proprietorship (SP): One-owner business
- Single-Member LLC: One-owner business
- Single-Person Corporation: One-owner business
Pay
- Sole Proprietorship (SP): The owner draws
- Single-Member LLC: The owner draws
- Single-Person Corporation: The owner is an employee and receives a salary and additional shareholder payments in the form of distribution in an S corp and dividends in a C corp.
Tax
- Sole Proprietorship (SP): The owner pays taxes on self-employment income (the owner’s “salary” is the draw from the business profits.)
- Single-Member LLC: The owner pays taxes on self-employment income (the owner’s “salary” is the draw from the business profits; same as a sole proprietorship.)
- Single-Person Corporation: The owner only pays taxes on income (salary) received as an employee in an S corp; the owner is double taxed on income (salary and dividend) received as an employee in a C corp.
Here are a few clarifications on specific aspects of single-member LLCs vs. sole proprietorships that may be helpful in understanding the above.
- Business entity: A single-member LLC can choose to be elected as either a C or S corporation. If they do not choose, then they are known as a disregarded entity. On the other hand, a multi-member LLC cannot choose to be a corporation and is one by default. Depending on its setup, a multi-member LLC is either a C or S corp.
- Legal status: In the case of a legal dispute, an incorporated single-member LLC, S corp, or C corp, should they elect to become a corporation, protects the owner’s personal assets from seizure. An unincorporated sole proprietorship makes the owner’s personal assets or unprotected assets liable in the same circumstances.
Benefits of Hiring a Sole Proprietor vs. Single-Member LLC
As an employer, engaging an independent contractor, either a sole proprietor or a single-member LLC, depends on your needs. Let’s take a look below at a few benefits of hiring both.
Market Credibility
Working with a person rather than a business could be a red flag for some companies. A sole proprietor could create a more trustworthy reputation with hiring companies by operating under a trade name. Typically, however, they’re not required to register for one. On the other hand, a single-member LLC may hold a higher level of market credibility because its process of incorporation would have involved a registered business name.
Financial Liability
A single-member LLC provides liability protection for its owner’s personal assets from creditors in the case of a legal dispute. This, in turn, provides peace of mind for the hiring business as it indicates the LLC’s overall financial stability. A single-member LLC also has better chances of securing equity or debt financing, adding to the hirer’s confidence.
In contrast, a sole proprietorship lacks financial protection (it is a company, not a corporation) of the owner’s personal assets in the face of a legal incident. As a result, it may experience more difficulty in obtaining debt financing as a business loan, which may be categorized by lenders as a personal loan instead due to its unincorporated status.
Independent Contractor Taxes
In the case of an independent contractor vs an employee, independent contractor taxes can be quite different regarding the filing process. It is the individual who is responsible for keeping track of and paying taxes as someone who is self-employed. However, It's good to be aware of exactly which taxes they are expected to file.
Independent contractor taxes vary significantly from one country to another, as the legal and economic systems of each nation shape tax laws and regulations. Here's a brief overview of how independent contractor taxes might be approached in different countries.
United States
Independent contractors in the United States are considered self-employed and are responsible for paying self-employment tax (Social Security and Medicare).
They must file a Schedule C or Schedule C-EZ to report their income and expenses, and estimated quarterly tax payments are typically required.
United Kingdom
In the United Kingdom, independent contractors often operate under a system known as IR35, which determines their tax status. Depending on their individual situation, some may be classified as "deemed employees" and subject to similar tax treatment as regular employees.
Others who are genuinely self-employed will pay taxes on their profits through the UK self-assessment system.
Canada
Independent contractors in Canada are considered self-employed and are responsible for paying both the employer and employee portions of the Canada Pension Plan (CPP) and Employment Insurance (EI). They must file a T1 tax return each calendar year and report their income and expenses. They will also need to remit Canada sales taxes if they earn above a certain threshold.
Australia
Independent contractors in Australia are responsible for their own taxes, including Goods and Services Tax (GST), if their annual turnover is above a certain threshold. They also need to report their income on a Business Activity Statement (BAS).
Germany
In Germany, independent contractors (Freiberufler) are subject to different tax rules than self-employed individuals (Gewerbetreibende).
Freiberufler are typically professionals like doctors, lawyers, and engineers that have specific tax obligations. Gewerbetreibende are considered tradespeople and have their own set of tax rules. Taxes must be reported to the Federal Central Tax Office (Bundeszentralamt für Steuern) in Germany.
France
Independent contractors in France (auto-entrepreneurs) have a simplified tax regime. They pay a percentage of their revenue in taxes, which includes both income tax and social security contributions. These must be reported and paid to the French Government.
India
In India, independent contractors are considered professionals and are taxed as per India’s Income Tax Act. They are also subject to Goods and Services Tax (GST) if an individual’s turnover exceeds a certain threshold.
Singapore
Independent contractors in Singapore are considered self-employed individuals and are subject to personal income tax. They do not, however, have to pay Central Provident Fund (CPF) contributions.
China
In China, individual service providers are subject to Individual Income Tax (IIT). The tax rate varies based on income levels.
These are general guidelines in regard to a few countries. It’s important to remember that many countries are not included on this list and that specific details can vary widely based on the nature of an individual’s work, income levels, and other factors. It is essential for independent contractors to consult with tax professionals or authorities in their respective jurisdictions to ensure compliance with local tax laws.
Does an LLC Pay Taxes the Same Way an Independent Contractor Does?
In terms of taxation, an LLC falls somewhere between an independent contractor and a corporation. An LLC can provide multiple owners tax benefits by offering a means to avoid possible double taxation that can be associated with corporate structures. If you are the sole owner of your LLC, you'll report taxes using a Schedule C (in the US), similar to a sole proprietorship. If ownership is shared, there are additional requirements.
By default, in the US, single-member LLCs are taxed the same way as sole proprietorships. However, an LLC can also choose to be taxed as an S Corporation or a C Corporation. This option allows LLC owners to choose the most cost-effective tax structure for their particular business.
Independent Contractor Taxes: US Example
What we’ve outlined above is simply an overview to demonstrate the variation of government requirements when paying independent contractor taxes around the world. To understand the intricacies of independent contractor taxes a bit better, let’s use the United States tax requirements as an example.
Self-Employment Tax
Independent contractors are considered self-employed. This means they’re responsible for employer and employee contributions to Social Security and Medicare taxes. This is known as self-employment tax.
Self-employment tax (SE tax) must be done by the self-employed individual using Schedule SE (Form 1040 or 1040-SR). They can also deduct the employer-equivalent portion of their SE tax from their adjusted gross income. They must also pay income tax on their reported income each year.
The self-employment tax rate in the US is 15.3% and consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).
Estimated Quarterly Taxes
Unlike traditional employees who have taxes withheld from their paychecks, independent contractors will need to pay estimated quarterly taxes on their own. This usually involves making estimated tax payments to the Internal Revenue Service (IRS) on a quarterly basis. These payments include both income tax and self-employment tax.
Individuals, including sole proprietors, partners, and S corporation shareholders, are typically responsible for making estimated tax payments if they expect to owe tax of US $1,000 or more when their end-of-year tax return is filed.
Form 1099-MISC
If you receive US $600 or more from a client within a tax year, they must send you a Form 1099-MISC. Form 1099 reports the income earned as an independent contractor.
LLC vs. 1099
So what about Form 1099 vs LLCs? An LLC with multiple partners is taxed as a partnership or corporation. Independent contractors, however, are only required to pay self-employment taxes. This means only independent contractors are required to fill out Form 1099 at the end of each year. LLCs are exempt from filing Form 1099-MISC.
State Taxes
In addition to federal taxes, independent contractors must also consider state and local taxes, which can vary significantly depending on where they live and work.
Tax Deductions and Credits
Independent contractors may be eligible for various deductions and credits to help reduce tax liability. These might include the Earned Income Tax Credit, health insurance deductions, and retirement plan contributions.
Legitimate Business Expenses can also be deducted. These can include expenses for supplies, equipment, travel, and more. If part of the contractor’s home is used exclusively for business, it may qualify as a related expense. This is known as a home office deduction.
Consider Professional Help
Given the complexity of tax regulations, it may be wise for independent contractors to work with tax professionals or an experienced Employer of Record (EOR) to ensure they are meeting their tax obligations correctly.
Tax laws and regulations can change, so it's always a good idea to stay informed or consult a tax professional for the most up-to-date advice and assistance.
Consider Borderless for All Your Global Hiring Needs
Is your business looking to engage international independent contractors but unsure where to start? Borderless has you covered.
Borderless is a global Employer of Record (EOR) platform designed to help companies like yours engage and manage international contractors. We take care of everything – from managing contracts to issuing payroll to ensuring that your business complies with local employment and tax laws.
Interested in partnering with us? Speak with our team today.
Disclaimer: Borderless does not provide legal services or legal advice to anyone. This includes customers, contractors, employees, partners, and the general public. We are not lawyers or paralegals. Please read our full disclaimer here.
