Working for Yourself Law & Taxes for Independent Contractors, Freelancers & Consultants By Attorney Stephen Fishman 7th edition SEVENTH EDITION FEBRUARY 2008 Editor ALAYNA SCHROEDER Cover Design SUSAN PUTNEY Production MARGARET LIVINGSTON Proofreader EMILY K. WOLMAN Index ELLEN SHERRON Printing CONSOLIDATED PRINTERS, INC. Fishman, Stephen. Working for yourself : law & taxes for independent contractors, freelancers & consultants / by Stephen Fishman. 7th ed. p. cm. ISBN-13: 978-1-4133-0752-8 (pbk.) ISBN-10 1-4133-0752-3 (pbk.) 1. Independent contractors Legal status, laws, etc United States Popular works. 2. Independent contractors Taxation United States Popular works. 3. Self-employed Taxation Law and legislation United States Popular works. I. Title. KF390.I54F57 2008 343.7305'26 dc22 2007035517 Copyright © 1997, 1998, 2000, 2002, 2003, 2004, 2006, and 2008 by Stephen Fishman. ALL RIGHTS RESERVED. PRINTED IN THE U.S.A. 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Table of Contents Your Legal Companion for Working for Yourself 1 1 Working for Yourself: e Good, the Bad, and the Ugly 3 Working for Yourself: e Good 4 Working for Yourself: e Bad 5 Working for Yourself: e Ugly 7 How to Use is Book 8 2 Choosing the Legal Form for Your Business 9 Sole Proprietorships 10 Corporations 15 Partnerships 30 Limited Liability Companies (LLCs) 31 3 Choosing and Protecting Your Business Name 37 Choosing a Legal Name 38 Choosing a Trade Name 38 Choosing a Trademark 42 Choosing an Internet Domain Name 45 Conducting a Name Search 45 4 Home Alone or Outside Office? 47 Pros and Cons of Working at Home 48 Restrictions on Home-Based Businesses 51 Deducting Your Home Office Expenses 55 Pros and Cons of an Outside Office 63 Leasing a Workplace 63 Deducting Your Outside Office Expenses 65 5 Obtaining Licenses, Permits, and Identification Numbers 69 Business Licenses 70 Employer Identification Numbers (EINs) 71 Sales Tax Permits 72 6 Insuring Your Business and Yourself 75 Health Insurance 77 Disability Insurance 87 Business Property Insurance 88 Liability Insurance 90 Car Insurance 92 Workers’ Compensation Insurance 93 Other Types of Insurance 94 Ways to Find and Save on Insurance 95 7 Pricing Your Services and Getting Paid 99 Pricing Your Services 100 Getting Paid 107 8 Taxes and the Self-Employed 123 Tax Basics for the Self-Employed 124 IRS Audits 131 Ten Tips to Avoid an Audit 134 9 Reducing Your Income Taxes 137 Reporting Your Income 139 Income Tax Deduction Basics 141 Business Use of Your Home 150 Cost of Business Assets 150 Car Expenses 155 Travel Expenses 160 Entertainment and Meal Expenses 163 Health Insurance 164 Start-Up Costs 165 10 e Bane of Self-Employment Taxes 167 Who Must Pay 168 Self-Employment (SE) Tax Rates 168 Earnings Subject to SE Taxes 168 Computing SE Taxes 169 Paying and Reporting SE Taxes 170 Outside Employment 170 11 Paying Estimated Taxes 173 Who Must Pay Estimated Taxes 174 How Much You Must Pay 175 When to Pay 178 How to Pay 179 Paying the Wrong Amount 181 12 Rules for Salespeople, Drivers, and Clothing Producers 183 Statutory Employees 184 Statutory Independent Contractors 187 13 Taxes for Workers You Hire 189 Hiring People to Help You 190 Tax Concerns When Hiring Employees 191 Tax Concerns When Hiring Independent Contractors 198 14 Record Keeping and Accounting Made Easy 205 Simple Bookkeeping 206 How Long to Keep Records 217 If You Don’t Have Proper Tax Records 217 Accounting Methods 218 Tax Year 221 15 Safeguarding Your Self-Employed Status 223 Who Decides Your Work Status? 224 What Happens If the Government Reclassifies You? 224 Determining Worker Status 226 e IRS Approach to Worker Status 227 Tips for Preserving Your IC Status 231 16 Retirement Options for the Self-Employed 237 Reasons to Have a Retirement Plan (or Plans) 238 Individual Retirement Accounts (IRAs) 239 Employer IRAs 242 Keogh Plans 243 Solo 401(k) Plans 244 Roth 401(k) Plans 245 Retirement Plans If You Have Employees 246 17 Copyrights, Patents, and Trade Secrets 247 Intellectual Property 248 Copyright Ownership 249 Patent Ownership 256 Trade Secret Ownership 256 Using Nondisclosure Agreements 257 18 Using Written Client Agreements 265 Reasons to Use Written Agreements 266 Reviewing a Client’s Agreement 268 Creating Your Own Client Agreement 269 Putting Your Agreement Together 270 Changing the Agreement After It’s Signed 273 19 Drafting Your Own Client Agreement 275 Essential Provisions 276 Optional Provisions 286 Sample Client Agreement 293 Using Letter Agreements 297 20 Reviewing a Client’s Agreement 303 Make Sure the Agreement Is Consistent With the Client’s Promises 305 Make Sure the Contract Covers at Least the Basics 305 Provisions to Avoid 305 Provisions to Consider Adding 310 Client Purchase Orders 310 21 Help Beyond is Book 313 Help Resolving Disputes 314 Finding and Using a Lawyer 317 Help From Other Experts 318 Doing Your Own Legal Research 320 Online Resources 323 Appendixes A Forms and Documents 325 Asset Log Expense Journal Income Journal Invoice B Sample Agreements 337 General Independent Contractor Agreement Contract Amendment Nondisclosure Agreement Index Your Legal Companion for Working for Yourself W orking for yourself gives you free- dom employees rarely get to experi- ence in their professional careers. Whether you label yourself “self-employed,” an “independent contractor,” a “free lancer,” a “consultant,” or even a “business owner,” you have a unique opportunity to choose how you’ll do business, where you’ll do business, and how the operation will run. Of course, with that freedom comes a lot of responsibility, too. You’ll generate your own work, choose and set up the right business entity, follow legal and tax rules, and maybe even manage other employees. e good news is, this book will help you do it. is book is a guide to law and taxes for people who either work for themselves or would like to. It covers all the legal and tax basics self- employed people need to know including: •thebenetsanddrawbacksofworkingfor yourself •thedierenttypesofbusinessentities,and which one is right for you •whethertoworkathomeorrentanoce •howtoinsureyourbusiness •howtopriceservices,writeclient agreements, and get paid •howtohandleyourtaxesanduseyourself- employed status to reduce them, and •howtomanageemployeesandrecord- keeping. is book is intended only for those self- employed people who provide personal services, such as writers, consultants, artists, photographers, lawyers, and doctors. If your business involves selling goods (rather than services) to the public, this book is not for you. Instead, you should refer to Legal Guide for Starting & Running a Small Business, by Fred Steingold (Nolo). As you will discover reading this book—if you haven’t found out already—being self-employed can be both a dream and a nightmare. ere are a lot of rewards and a lot of risks. e goal of this book is to help you navigate the risks so that they do not detract from the rewards, which we hope will be rich and plentiful. ● 1 CHAPTER Working for Yourself: e Good, the Bad, and the Ugly Working for Yourself: e Good 4 Independence 4 Higher Earnings 4 Tax Benefits 5 More Privacy 5 Working for Yourself: e Bad 5 No Job Security 6 No Free Benefits 6 No Unemployment Insurance 6 No Workers’ Compensation 6 No Free Office Space or Equipment 6 Few or No Labor Law Protections 6 Complete Business Responsibility 7 Others May Discriminate 7 Working for Yourself: e Ugly 7 Double Social Security Tax 7 Personal Liability for Debts 7 Deadbeat Clients 7 How to Use is Book 8 Starting Up Your Business 8 Ongoing Legal and Tax Issues 8 4 | WORKING FOR YOURSELF W orkingforyourselfcanbebothnan- cially and spiritually satisfying. But the lot of the self-employed is not always an easy one. You have to make the often diculttransitionfromhavinganemployertake care of you to handling everything on your own. For example, you won’t have a company payroll department to withhold and pay your taxes for you. Many self-employed people (including those with plenty of clients) get into trouble because they don’t run their operations in a businesslike manner. Spending a few hours now to learn the nuts and bolts of self-employment law and taxes can save you countless headaches—not to mention substantial time and money—later on. You don’t have to start wearing a green visor and bow tie, but you do need to learn a few rudiments of business and tax law. Before you delve into the details of the following chapters, read this chapter for an overview of the pros and cons of being self-employed as compared to being an employee. It may help you make an informed decision if you’re thinking about striking outonyourown—orhelpconrmthatyoumade the right decision if you’re already working for yourself. Working for Yourself: e Good Being self-employed can give you more freedom and privacy than working for an employer. It can alsoresultinsubstantialtaxbenets. Independence When you’re self-employed, you are your own boss—with all the risks and rewards that entails. Most self-employed people bask in the freedom that comes from being in business for themselves. ey would doubtless agree with the following sentiment expressed by one self-employed person: “I can choose how, when, and where to work, for as much or as little time as I want. In short, I enjoy working for myself.” e self-employed are masters of their own economic fates. e amount of money they make is directly related to the quantity and quality of their work, which is not necessarily the case for employees. e self-employed don’t have to ask theirbossesforaraise;theygooutandndmore work. Likewise, if you’re self-employed, you’re normally not dependent upon a single company for your livelihood,sothehiringorringdecisionsof any one company won’t have the same impact on you as on that company’s employees. One self- employedpersonexplains:“Iwaslaidosixyears ago and chose to start my own company rather than sign on for another ride on someone else’s rollercoaster.It’sscaryatrst,butI’mnowno longer at someone else’s mercy.” Higher Earnings You can often earn more when you’re self- employed than as an employee for someone else’s business. Forexample,anemployeeinapublicrelationsrm decided to go out on her own when she learned thatthermbilledhertimeouttoclientsat$125 perhourwhilepayingheronly$17perhour.She nowcharges$75perhourandmakesafarbetter living than she ever did as an employee. According to the Wall Street Journal, self- employed people who provide services are usually paid at least 20% to 40% more per hour than employees performing the same work. is is becausermsthathireself-employedworkers (referredtothroughoutthisbookas“hiringrms”) don’t have to pay half of the self-employed worker’s Social Security taxes, or pay for unemployment compensation taxes, workers’ compensation coverage,oremployeebenetslikehealthinsurance and sick leave for workers who are not their employees. Of course, how much you’re paid is [...]... Corporate Form Although there are many advantages to incorpo­ rating, there are also some disadvantages You’ll have to maintain minimal corporate formalities that will take some time and effort And you’ll have to pay some taxes and fees that other business entities don’t pay Corporate Formalities The IRS and state corporation laws require corporations to hold annual shareholder meetings and document... 33 Pros and Cons of an LLC 33 Forming an LLC 35 10 | working for yourself A s a self-employed person, one of the most important decisions you have to make is what legal form your business will take There are several alternatives and the form you choose will have a big impact on how you’re taxed, whether you’ll be liable for your business’s debts, and how the IRS and state... self-employment taxes —that is, Social Security and Medicare taxes on their net self-employment ­ncome These taxes i must be paid four times a year (along with income taxes) in the form of estimated taxes Chapters 10 and 11 will cover this in more detail • partnership, and • limited liability company If you own your business alone, you need not be concerned about partnerships; this business form requires... must pay both income and self-employment taxes on this profit 12 | working for yourself Businesses Owned and Operated by Spouses Many businesses are co-owned by a husband and wife These businesses can be organized in a variety of ways—as an S or C corporation, a limited liability company (LLC), or a formal partnership If you and your spouse don’t take any steps to choose a business form, the IRS will... behave as if they and the corporation are one and the same, without following the formalities required for corporate status For example, they fail to contribute money to the corpo­ ation or issue stock, they take corporate r funds or assets for personal use, they commingle chapter 2 | choosing the legal form for your business | 19 corporate and personal funds, or they don’t observe corporate formalities... her own workplace and equipment Few or No Labor Law Protections A wide array of federal and state laws protect e ­ mployees from unfair exploitation by employers Among other things, these laws: • impose a minimum wage • require many employees to be paid time and a half for overtime • prohibit discrimination and harassment • require employers to provide family and medical leave, leave for military service,... guidance about tax deductions, and prepare tax returns for you minimum $800 franchise tax to the state every year after their first year in business, even if the corporation has no profits Fortunately, you can deduct any state and local fees and taxes from your federal income taxes as business expenses Forming a Corporation You create a corporation by filing the necessary forms with and paying the required... 20 | working for yourself see an expert If, after reading this chapter, you’re not sure whether a C or S corporation is best for you, consult an accountant or other tax professional for help (See Chapter 21.) Taxes for C Corporations When you form a corporation, it automatically becomes a C corporation for federal tax purposes C corporations are treated as separate entities from their owners for tax... afford a loan, you’ll likely have to provide a prospective lender with copies of your recent tax returns and a profit-andloss statement for your business Working for Yourself: The Ugly Unfortunately, the bad aspects of self-employment discussed above do not end the litany of potential woes Being self-employed can, in some respects, get downright ugly Double Social Security Tax For many, the ugliest and. .. tax-deductible business expenses (see Chapters 9 and 14) If you’re just starting out, there are a number of tasks you’ll need to complete before or soon after you start doing business These include: • dealing with taxes for any employees or independent contractors you hire (see Chapter 13) • choosing the legal form for your business (see Chapter 2) • choosing a name for your business (see Chapter 3) • deciding . Working for Yourself Law & Taxes for Independent Contractors, Freelancers & Consultants By Attorney Stephen Fishman 7th edition SEVENTH EDITION FEBRUARY. PRINTERS, INC. Fishman, Stephen. Working for yourself : law & taxes for independent contractors, freelancers & consultants / by Stephen Fishman. 7th ed. p. cm. ISBN-13: 978-1-4133-0752-8. Legal Companion for Working for Yourself 1 1 Working for Yourself: e Good, the Bad, and the Ugly 3 Working for Yourself: e Good 4 Working for Yourself: e Bad 5 Working for Yourself: e Ugly 7 How