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Transitioning from an independent contractor to a business owner

by | Jun 13, 2022 | Business Law

Many individuals formerly working as 1099 independent contractors in California must now form legal business entities to provide their services. As explained by Small Business Trends, California’s AB5 law, enacted in 2020, requires companies to only work with third-party contractors who perform different services than their employees.

To solicit contractual service arrangements, an individual may register a legal business entity. A name is generally chosen that describes the business’s purpose and offerings. Depending on the location and services, an owner may also need to apply for a permit or license and purchase liability insurance. The IRS typically allows small businesses to deduct these expenses on their tax returns.

Creating a small business may bring tax advantages

Subchapter S corporations and limited liability companies reflect two common business ownership structures. As noted by The Blueprint, the benefits include paying taxes only on the profits that flow to an owner.

Instead of paying taxes on the business’s net income, an owner may deduct all applicable expenses incurred to provide services and cover marketing costs. An owner then records the remaining funds as profits on his or her personal income tax return, which may result in tax savings not available to a traditional 1099 independent contractor.

Obtaining a business loan may provide needed growth capital

After creating a legal business entity, an owner may have an option to increase production or service capacity by applying for a business loan. A startup loan may provide sufficient capital to purchase a new truck or needed equipment.

Prior to the passage of AB5, an independent contractor generally had to incur personal loans or pay for expenses related to “gig” work with his or her credit cards. Forming a legal business structure may bring tax savings and also provide additional sources of funding.