1099 vs. LLC: Understanding the Differences

When trying to find out something about taxes for independent workers, you may have heard about such things as LLC and 1099. 

Yet, small things like understanding taxation and local law might look challenging for an independent contractor to resolve independently.

In this blog, readers will find the easiest way to compare 1099s and LLCs so they can easily understand the pros and cons of each. 

We also look at how to form an LLC and the situations in which it is better to file a 1099 or register an LLC.

What is a 1099 Independent Contractor?

The IRS defines 1099 independent contractors as individuals who control what work will be done and how it will be done. 

The person who avails of their services may only direct the result of the contractor’s work. 

In other words, a 1099 independent contractor is any contractor, freelancer, or self-employed worker who is paid according to an agreement with their client. They are not employees of a company and do not get fixed salaries.

1099 contractors enjoy great flexibility in managing their workload and schedule. They may choose to work for multiple organizations and set their rates independent of those prevailing in the market.

Independent contracting has its risks, which are as follows: Every year of operation, self-employed persons have to prepare and submit their annual self-assessed tax returns and pay taxes for each quarter of the financial year. 

Typically, specific contracts need the independent contractors to pay income taxes together with the self-employment taxes, which are proportional to the Medicare and Social Security taxes on employees’ wages. 

Further, they are exposed to getting sued by their client when carrying out services, hence incurring personal costs if they are held responsible for loss of property or bad work.

Pros and cons of being a 1099 Independent Contractor

Being a 1099 independent contractor comes with its perks.

Pros

• 1099 contractors have a lot of freedom when it comes to choosing their working hours, working location, projects, and service rates.
• They generally have more earning potential as they can set their rates for the services they offer, which can be higher than the market rate.
• Independent contractors work on a myriad of projects with companies with highly diverse backgrounds. This makes them more likely to have a diverse skill set capable of handling highly niche and specialized requirements.
• 1099 tax benefits include tax deductions such as retirement plan contributions, health insurance premiums, home office costs, and other deductions for meals, travel, internet bills, and education expenses, among others.

Cons

• Due to the contractual nature of work, 1099 contractors may be at risk of unpredictable workflows, irregular income, and potential bankruptcy.
• Apart from managing their work commitments, they are required to handle their insurance and tax obligations single-handedly.
• They are often ineligible for workers’ compensation benefits like 401(k) and unemployment insurance and may not qualify for car loans, mortgages, or related loans.
• 1099 does not protect contractors against personal liabilities in case the client sues the contractors for damages or does not meet work requirements.

What is an LLC?

An LLC stands for a Limited Liability Company, a business structure adopted by the owners to get the advantages of a corporation; meanwhile, they do not merge their personal comprehension with the company if the business turns into financial or legal trouble. 

An LLC provides great advantages to the business owners, among which are the limitation of the entity’s owner’s legal responsibility, the establishment of LLC’s resources’ difference from its members’ resources, and other aspects of LLC formation and taxation. 

An LLC can elect to be taxed as a corporation, partnership (in the case of the LLC having two or more members), or what is regarded as a ‘ disregarded entity’ (the LLC shall be treated on the tax return of the LLC contractors). 

Different sources have different say on the maximum number of members an LLC can include, but per the LLC law, there is no such limitation. 

LLCs can elect sole proprietorships and partnerships, or the business can be established as an S-Corp or C-Corp. 

The earnings or losses from an LLC pass through to the individual income tax returns of its owners or members for all LLCs other than C-Corps, which are only taxed once.

Key Differences Between 1099 And LLC

While the tax liabilities and deductions for 1099s and sole-proprietorship LLCs might be similar, they have some differences based on liability, taxation, registration, and business operations.

Liability Protection

An LLC allows the company to be treated as an entity separate from its owners. This means the owners are protected from being personally sued or pursued by creditors for debts or lawsuits. 

Conversely, 1099 contractors are not protected against personal liability and face the risk of unlimited personal liability for any legal actions against the business.

Taxation

Coming to the key differences between 1099 contractor vs LLC, the former are obligated to pay a self-employment tax in addition to their income tax. 

This is different from LLCs where taxation depends on the classification of the business. 

For example, the profits or losses incurred by LLCs who elect sole proprietors, partnerships, or S-Corps pass through the owners’ taxations, enabling them to avoid double taxation. 

C-Corps are taxed both at corporate and individual levels.

Business Structure

Compared to LLCs, 1099 operations offer simplicity regarding business formalities. As independent contractors, 1099 workers do not need to file entity formation documents or stringent operating agreements. 

On the other hand, LLCs have more opportunities for scalability than 1099 workers, as it is possible to employ individuals, add stakeholders, and raise capital. 

1099 workers generally cannot hire employees working under them or set up payroll and tax benefits effectively, a downside that LLCs avoid.

Benefits of Forming an LLC for Independent Contractors

Now that you are aware of the basics of LLCs and 1099 contractors, let's examine the benefits of independent contractor vs. LLCs and their growth potential.

Tax Benefits of LLC vs Independent Contractor

Read the table below to understand the tax benefits of independent contractors vs LLCs.

Business Growth Potential

Among the other benefits of an LLC for independent contractors is the potential for business growth. 

The table below summarizes the growth potential of LLC vs contractors.

Thinking - ‘Do I need an LLC as an independent contractor’, ‘Should independent contractors form an LLC’ or ‘Does LLC corporation get 1099’ - Read on for answers.

When Should You Choose a 1099 vs an LLC?

Does this mean that forming an LLC is always better than a 1099? Not quite. 

Depending on long-term goals, income levels, and risk tolerance, either can be a good option for an LLC vs a 1099 contractor in different scenarios. 

Ideal Scenarios for 1099

Some situations where bringing a 1099 contractor is better include:

• If you are just starting and need a simpler setup with minimal need for filing administrative and business documents
• If you are a freelancer working on short-term projects without significant liability concerns
• If you want to kickstart and run your business without worrying about the complexity of compliance and formation costs

Ideal Scenarios for LLC

If you are wondering, “Should I form an LLC as an independent contractor?” here are some scenarios you might consider the answer to be a yes:

• If your work is at higher risk of liabilities and you want to protect your personal property and assets against confiscation due to company debts and lawsuits
• If you are involved in long-term projects with multiple clients and are looking to upscale your business considerably in the future
• If you have a significant income stream and want to avail the tax savings that come along with being an S-Corps LLC
• If you want to enhance the image and credibility of your business

Steps to Form an LLC

Forming an LLC is a multi-step process that can leave many confused and overwhelmed. 

However, registering as an LLC is not as complex as it seems. Here is a detailed guide on how you can set up an LLC.

Registration Requirements

The registration requirements to establish an LLC may vary from state to state. Thus, you must thoroughly understand the requirements to register as a business entity in the state of your choosing.

• The first step to forming an LLC is to choose a name for it. Ensure that the name is memorable and resonates with the brand identity and impact you wish for it to create. 
• Next, check with the United States Patent and Trademark Office to ensure your chosen name is not trademarked by someone else. Further, avoid using restricted terms such as “insurance” or “bank” unless you are pre-approved to use them.
• Note a registered agent who will be to receive any legal documents on the LLCs behalf and be responsible for managing lawsuits and other legal matters. Generally, a registered agent must be over 18 years of age and be a resident of the state where the LLC is registered. You can hire an individual agent, a registered agent service, or acting as your registered agent.
• Once that is done, you can prepare and submit the relevant documents required for registration. Consult a business attorney to draft an operating agreement outlining the business’s structure and operation guidelines. 
• The articles of organization are another important set of documents for LLC registration. They include the LLC’s name, address, duration of formation, purpose, management information, details about the registered agent for the LLC, and signatures of the LLC organizers. You can now apply for the document submission process for LLC registration online.

That is all you need to establish an independent contractor LLC!

Legal and Tax Compliance

Tax compliance guidelines and legal obligations differ from state to state. 

Failing to comply with these laws and guidelines is one of the major risks of the globalization of human resource management. 

Thus, ensuring compliance with state laws and tax compliance guidelines is essential after completing the registration requirements.

• Apply to the IRS for an Employer Identification Number (EIN) on their official website at no additional cost. The EIN is used to identify your LLC for taxation purposes. While owners of sole proprietorships and S-Corps can use their Social Security Numbers for tax purposes, EINs are a requirement to open business bank accounts at many financial institutions. Besides, using EINs even as a single-member LLC protects your privacy.
• Ensure you have all the required licenses and permits to operate your business in your chosen state. Ensure that you diligently fill out proper forms and follow all applicable tax rules. Some states require additional fees to conduct business in the state, so research state compliance laws well.
• Finally, be sure to maintain meticulous record-keeping, regularly update operating agreements, conduct annual meetings, and issue shares to LLC members.

Wondering ‘Do limited liability companies get 1099 forms’ - Here’s your answer!

Does an LLC Corporation Get 1099 Forms?

Whether a company is required to send a 1099 for LLC is subject to the kind of business structure they choose to identify as. 

Single-member sole proprietorships can be treated as a “person” during the tax filing. In this case, the LLC can be issued a 1099. 

On the other hand, an LLC that identifies as an S-Corp or C-Corp generally does not receive a 1099 as they are treated as a corporation.

How Skuad Can Help You Manage Independent Contractors and Employees Globally

With location no longer a barrier to scouting expert contractors, hiring global talent can take your business to the next level. However, staying on top of local hiring laws and tax compliance can become an extra hassle that hinders your business growth.

This is where Skuad can help. Skuad’s professional tools and expertise empower your business with global hiring tools that help you seamlessly manage payrolls from a single platform. Ensure legal compliance worldwide and expand your business to be truly international.

Skuad helps you effortlessly manage compliance with local tax laws and manage independent contractors worldwide. Find out how Skuad can transform your business today!

FAQs

1. Which is better, LLC or 1099?

Whether an LLC or 1099 is better depends on business goals, income volume, and ability to take risks. Each independent contractor's factors are unique, so do your research to determine which would be better for your business.

2. Is it better to file taxes as self-employed or LLC?

Depends on the legal structure and operations of the business. For short-term projects with minimal liability, it may be better to file self-employment taxes. If you want to avoid personal liability for business debts and lawsuits or plan to upscale your business, an LLC might be a better option.

3. Do you need a 1099 if you are an LLC?

A 1099 may be required for sole proprietorships as they can be considered a single person providing a service. This does not apply to S-Corps or C-Corps, which are taxed as corporations instead.

4. Is 1099 the same as owning a business?

When you have a 1099, the IRS considers you a business owner, even if you are a solo contract worker.

5. What type of LLC is best for taxes?

The tax structure best suited for your LLC depends on the number of members, operations structure, income, and financial setup.