LLC vs. 1099: What’s the Difference for Contractors?
Independent contractors often mix up their tax reporting status with their business's legal structure. This guide clarifies the relationship between the two.
For many independent professionals, the terms “1099” and “LLC” can create confusion. The core of the issue lies in understanding that these terms represent fundamentally different aspects of being self-employed. One is a tax reporting mechanism, while the other is a formal business structure. This distinction has significant legal and financial consequences, and navigating self-employment requires a clear grasp of both your tax classification and the legal framework of your business.
Understanding Your Status as a 1099 Contractor
When you perform services for a client as an independent worker, you are often referred to as a “1099 contractor.” This label originates from the IRS tax form your clients use to report the income they pay you. If a client pays you $600 or more in a calendar year, they are required to send you and the IRS a Form 1099-NEC for Nonemployee Compensation. This form documents your earnings but does not define your business’s legal structure.
By default, an individual working for themselves is considered a sole proprietor by the IRS. This is the simplest business structure and requires no formal action to create. As a sole proprietor, there is no legal distinction between you and your business, meaning you are personally responsible for all business debts and liabilities. If your business is sued or cannot pay its debts, your personal assets, such as your home or savings, could be at risk.
A significant financial aspect of being a 1099 contractor is the responsibility for self-employment taxes. Unlike traditional employees, you must pay the full amount of Social Security and Medicare taxes yourself. The total self-employment tax rate is 15.3%, which breaks down into 12.4% for Social Security and 2.9% for Medicare.
This tax is calculated on 92.35% of your net business earnings. The 12.4% Social Security tax applies only to earnings up to an annual limit, which is $176,100 for 2025. The 2.9% Medicare tax applies to all of your net earnings with no income cap. Because no taxes are withheld from your payments, you are also responsible for making estimated tax payments to the IRS throughout the year to cover both self-employment and income taxes. All business income and expenses are reported on Schedule C, filed with your Form 1040 tax return.
What is a Limited Liability Company (LLC)
A Limited Liability Company (LLC) is a formal business structure authorized by state statute. Unlike a sole proprietorship, an LLC must be officially created by filing specific documents with the state. The primary feature of an LLC is that it is a separate legal entity from its owners, who are called “members.”
The core benefit of forming an LLC is the “limited liability” protection it offers. This means that an owner’s personal assets are generally shielded from the business’s debts and legal obligations. If the LLC incurs debt or is sued, creditors and litigants can typically only pursue the assets owned by the LLC itself. Your personal property, such as your house and personal bank accounts, are protected.
This legal separation provides a layer of security that is valuable for businesses that might face risks of lawsuits or significant financial obligations. To ensure the liability protection remains intact, you must maintain this separation. This involves practices like keeping business and personal finances completely separate with a dedicated business bank account. If an owner commingles personal and business funds, a court could “pierce the corporate veil,” removing the liability protection.
Tax Implications and Choices for an LLC
By default, the IRS treats a single-member LLC as a “disregarded entity.” This means that for federal income tax purposes, the LLC is not considered separate from its owner. The LLC’s income and expenses are reported on the owner’s personal tax return using Schedule C, exactly like a sole proprietorship. The owner still pays self-employment taxes on all net profits.
This default status offers the legal protection of an LLC while maintaining the tax simplicity of a sole proprietorship. However, an LLC can elect to be taxed as an S Corporation by filing Form 2553 with the IRS. This election changes how the owner’s income is treated for tax purposes, potentially leading to savings.
When an LLC is taxed as an S Corp, the owner must pay themselves a “reasonable salary” as a W-2 employee of the company. This salary is subject to payroll taxes for Social Security and Medicare. The remaining profits of the business can then be distributed to the owner as a “distribution.” These distributions are not subject to self-employment or payroll taxes, only regular income tax.
For example, consider an LLC with $100,000 in net profit. As a disregarded entity, the full $100,000 is subject to the 15.3% self-employment tax. If the LLC elects S Corp taxation and the owner pays a reasonable salary of $60,000, only that salary is subject to payroll taxes. The remaining $40,000 can be taken as a distribution, which is not subject to the 15.3% tax. The IRS requires the salary to be reasonable for the industry and work performed.
Forming an LLC
Information and Documents Needed
Before filing, you must choose a unique business name that complies with your state’s naming rules. The name must not be deceptively similar to any existing business registered in that state and must include an indicator like “LLC” or “Limited Liability Company.” You will also need to appoint a Registered Agent, a person or company designated to receive official legal and tax documents on behalf of the LLC at a physical street address in the state.
The central document for creating an LLC is the Articles of Organization. While the specific requirements vary by state, this form requires the LLC’s name and address, the name and address of the Registered Agent, the business’s purpose, and the names of its members or managers.
The Filing Process
Once the Articles of Organization are complete, you must file the document with the designated state agency, which is usually the Secretary of State. This can be done online or by mail and requires the payment of a filing fee that can range from approximately $50 to $250. After the state processes and approves your filing, your LLC legally exists.
With the LLC officially formed, the next step is to obtain an Employer Identification Number (EIN) from the IRS. An EIN is a unique nine-digit number that acts as a Social Security number for your business, and you can apply for one for free on the IRS website. This number is necessary for opening a business bank account, hiring employees, and filing business tax returns, including when making an S Corp election.