Independent Contractor - better to file as sole proprietorship, LLC, or S Corp

[C1duncan]

I have an opportunity for a short-term, full-time contract role in California. The salary for the 3-month contract will likely be less than $50k. Is it best to just set aside the 15% for federal taxes to pay as a sole proprietorship or open an LLC? As a contractor, do I pay taxes quarterly? If the contract were to be extended and I were to make more than $50k, I understand there could be tax benefits to opening an S Corp.

How can I best minimize my tax liability? What are the implications for state taxes? Are there any other tax requirements I should be aware of as someone new to contract work? What questions should I ask the employer to ensure I am protected?

[CatinaT1 · Accepted solution]

For a short-term contract under $50,000, sticking with a sole proprietorship and filing a Schedule C is the best option.  

With a sole proprietorship, there is zero cost to set up and you report your income and expenses on a "Schedule C" with your personal tax return.

Managing an LLC in California is expensive and because of their annual fee and since your contract is short term, it's not cost effective.

You won't save on income tax by having an LLC. An LLC is a business classification, not a tax classification. 

You are correct that an S Corp offers tax benefits, but it is rarely worth the cost of maintaining it unless you are consistently making more money on a consistent annual basis.

As far as how much to set aside, I would recommend more than 15%. Your self employment tax alone is 15.3% on your net earnings. You have income tax in addition to that. I generally suggest setting aside 25%. This is not taking into consideration any tax owed to the state. I would suggest setting aside an additional 5-8% for California

If this will be your first year filing a Schedule C, you likely don't need to make estimated payments. But if you want you can. Here is more information on making quarterly payments.

As a self employed person,  you can deduct "ordinary and necessary" business expenses to lower your taxable income. Common deductions include:

Home Office: If you use a portion of your home exclusively for work.

Equipment: Laptops, software subscriptions, or furniture purchased specifically for the role.

Professional Services: Fees for an accountant or legal advice.

You can find more information on business expenses here. 

For your question about what questions you should ask the employer to ensure you are protected, remember, as an independent contractor, you don't have an employer - you are your own employer. Who you are working for is not protecting you. Depending upon the type of work you are doing, it's possible you may need liability insurance or other licenses. 

The IRS Self-employed individuals tax center would be helpful for you. California has a similar site.