Last week we talked about being an employee vs. independent contractor – mostly from the classification point of view. This week I wanted to expand that a little and talk about the advantages and disadvantages of owning your own business and becoming an independent contractor.
WHAT ARE THE ADVANTAGES OF BEING AN INDEPENDENT CONTRACTOR?
There are tax benefits and there are non-tax benefits.
Let’s talk about the non-tax benefits. When you run your own business, it provides you with flexibility. You control your own schedule. You are independent because you are your own boss. You get to make the decisions on how the business operates. But from a tax point-of-view, it allows you to do things that you just can’t do now under the new law, as if you were an employee. For example, your employee business expenses are deductible if you run your own business. So things like mileage, tools, supplies, cell phones, and even a part of your home if you use it exclusively for your business can be deducted.
Under the old rules, as an employee, you could deduct those expenses as miscellaneous deductions, but that has gone away with the new tax law. That is why these benefits are really now only available if you run your own business, but not if you are an employee anymore.
You can also do retirement plans, such as 401(k) plans, simple plans, and SEP’s. Even though you are just a one-person operation, you can still do your own retirement plans.
WHAT ARE THE DISADVANTAGES?
The biggest disadvantage in my eyes is that you do not get unemployment benefits. Therefore, if work slows down or if something happens, you cannot rely on those unemployment benefits to get you through that time. You also need to supply your own insurance, tools, and other things.
When you are an employee, a lot of those things are supplied by your employer. But as a self-employed individual, you have to do those things. You have to remember that when you are making this transition, you should build those into your prices that you charge to your customers. There is also no withholding on a W-2. You might have to pay your own estimated taxes. Speaking of estimated taxes, that includes what is called a self-employment tax. As an employee, you pay one-half (1/2) of your Social Security and Medicare, and your employer pays the other half. Now you are both the employee and the employer, so you pay both halves. This can sting some people that aren’t aware of that, and you really need to watch your cash.
HOW DOES A PERSON GET STARTED IN OWNING THEIR OWN BUSINESS?
Certainly, you have to have that self-employed mindset. You have to want to do your own thing. But from an accounting point of view, it is essentially a matter of doing four (4) things:
1. Choosing the type of entity you want to be;
2. Getting an employer identification number;
3. Setting up a business bank account; and
4. Setting up an accounting system to see if you are making any money or not.
Individuals should weigh the advantages and disadvantages of owning their own business, and it is really important to get counseling from your attorney or your accountant to make sure you get that business set up correctly right from the start.