Becoming an Independent Contractor

If you structure your job properly, you can turn an employer into a client and end up getting more money for doing the same job by becoming an independent contractor. Your former employer no longer has to pay your Social Security, unemployment compensation taxes, or workman's compensation benefits. And he is free from the bookkeeping headaches of calculating and deducting Social Security and income taxes and forwarding the money to the government, of processing paperwork for your health insurance, and of providing you with supplies. You may be able to negotiate splitting some of those savings with your boss when you go solo. Thousands of mainstream folks do it each year. House painters, floor layers, researchers, writers, custom seamstresses, management experts, engineers, carpenters, electricians, insurance claims processors, bookkeepers, and people from dozens of other fields successfully turn to private contracting, at least in part as a means of reducing taxes. Independent contracting won't relieve you completely of taxes. But you pay income tax only after deducting all your business expenses, including some personal and fringe benefit expenses. In addition to income taxes, you pay Social Security tax, in the form of "self-employment tax," which is about 2% or 3% less than the tax companies pay for employees. The IRS is well aware of the tax benefits of being an independent contractor, so follow the rules. One mistake, and the IRS may attack. The courts tend to back up the IRS on this issue. You also cannot dodge tax withholding by going out on your own. You must estimate your income taxes for the coming year and send a quarter of the estimated amount to the federal and state government each calendar quarter. The key to determining whether you are an employee or a contractor is the degree of control you have over your work. The more control you have, the more you look like an independent contractor. The more your boss can boss you around, the more you look like an employee.

To appear independent, at least to the IRS, you have to control the number of hours you work and when you work them. It also helps to get paid by the product rather than by the hour. A true independent contractor should also control everything about a job except the result. Your client generally cannot dictate how to reach that result. His only legitimate concerns are the quality of your product and how long it took you to do it. Eventually you'll need to pick up more clients. If you work as an employee for a number of years, then convert to independent contractor status, you could be in trouble if you still spend 90% of your time working for your former boss. The IRS may view this as an employment relationship. Try to line up small assignments with other firms as soon as possible. This may seem tough, but you'd be surprised how many new independents get flooded with work. Another sticky point with the IRS is office space. You must have an office in your home or somewhere other than on your former employer's business premises. Some advisers say you should only have office space you pay for if you want to look like an independent contractor.

Also, pay for your own office supplies and equipment. Make sure you have basic supplies that make you look like a business such as stationery and business cards. Put together a written contract covering all these points. It can be as simple as a "letter of agreement" between you and your new clients outlining the product you will deliver, when it is due, and what your fee will be. Having a contract doesn't seal your case, but it creates a strong presumption in your favor. The IRS will check the facts to see if the parties are abiding

by the contract. Under new tax laws, the IRS looks more closely at these arrangements than in the past. If you plan to work as an independent contractor for just one company, it's a good idea to talk to a professional tax advisor. A change to consultant with your current employer will allow you to negotiate your benefits to a dollar value included in your fees. Take into account the value of benefits such as sick leave, employee discounts, and health, disability, and life insurance. As an unincorporated business, you must pay for these items yourself, and for the most part, they are not deductible on your tax return. The self-employment Social Security tax of 12.3% is a big bite and is not deductible for you or the business. Balance this with the benefits

If you're not sure about breaking away from the security of your job right away, start with a sideline business in your spare time. You can keep your present job while starting on the road to self-employment and make the full-time jump later, if ever. The easiest way to do this is to make a business out of something that you love to do and are spending time and money doing anyway. Whenever you can convert a personal expense into a business expense, you can save tax dollars. Even if you're not realizing profit on it you may as well gain the tax advantage. There are countless sideline business possibilities: real estate, accounting, free-lance writing, graphic art, auto repair, teaching night school, and tutoring. If you make crafts for friends and relatives, start selling them at flea markets and fairs. Look for distant craft shows, combine the business with your vacations and write off not only the craft supplies but also part of your vacations.