If you're interested in becoming an independent contractor but not sure what it entails, you've come to the right place.
What is the legal definition of an independent contractor? According to the IRS website, “the general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done.”
Essentially, an independent contractor is someone who is self-employed and provides certain services to a second-party, the principal (or client or owner), or to a third-party on behalf of the client — and you can become an independent contractor in your field.
Employee vs. Independent Contractor
But you might be wondering, what is difference between an employee and an independent contractor?
"An independent contractor is not under the control, guidance or influence of the client and, unlike an employee, does not owe a fiduciary duty," according to Business Dictionary. "The client neither deducts the payroll (or the withholding) taxes from payments to the independent contractor, nor contributes the employer's share. To be legally designated as an independent contractor, an individual must (1) be free from the control of the client, (2) be able to exercise his or her judgment as to the manner and methods to accomplish the end-result, and (3) be responsible for the end-result only under the terms of the contract."
Freelancer vs. Independent Contractor
You might also be wondering what is the difference between a freelancer and an independent contractor?
Freelancers and independent contractors are essentially one in the same, and the terms are often used interchangeably. But there can be some differences.
"A freelancer is considered a self-employed person who pays their own self-employment taxes, doesn’t have any employees, sets their own rates, works remotely at their own location wherever they choose, chooses which projects they want to work on [and] works with multiple clients or just one," according to MileIQ. "Freelancers generally work on a project with expected outcomes for an agreed fee. The freelancer retains control over how to get the work done, working when and where they choose. Of course, the project is subject to agreed deadlines and outcomes. Freelancers may even subcontract the work to others, should they choose. The original organization has no control over how the work gets done."
An independent contractor, however, might function as a freelancer (and they often do), but they'll also typically work with one client for a longer time frame than the average freelancer. Another difference is that they might work through a third party or via an agency, though they can also work on their own. If they do indeed work independently, they're responsible for their own taxes and insurance, while an agency might otherwise be responsible for their taxes.
So if you're thinking, how do I pay taxes as an independent contractor?, the answer varies based on the type of working relationships you have with your employers. As an independent contractor, however, you'll use the form 1099-MISC, an IRS tax return document used to report miscellaneous payments made to nonemployee individuals.
What Classifies an Independent Contractor?
An independent contractor should be contracted to perform work or provide services to another entity, specifically, as a non-employee — and this is hugely important for tax purposes. The employer must correctly classify each payee as either an independent contractor or an employee. This is because independent contractors are required to pay their own Social Security and Medicare taxes.
Independent contractors work in many different industries. Here are some examples of independent contractors:
- Consulting Agency
- Real Estate Agent
- Editorial Agency
- Marketing Agency
Why Do Companies Use Independent Contractors Instead of Employees?
Companies use independent contractors instead of employees for a multitude of reasons, some of which are quite contradictory.
"Employers must withhold taxes for their employees and pay half of their Social Security and Medicare taxes; instead of hiring new employees and paying an additional 30 percent or more in payroll taxes and benefits, many companies chose to make 'work-for-hire' arrangements with independent contractors," according to Inc. "Businesses, and especially small businesses, can gain several advantages from such arrangements. For example, employers are not responsible for paying taxes for freelance employees, and they avoid the high costs of providing health insurance, paid vacation and sick leave, and other benefits often granted to regular, full-time employees."
Furthermore, employers that use independent contractors don't have the risk of costly litigation over hiring, promotion, firing and other employment practices. Rather, all these employers have to do is simply file a form 1099 with the government to report the total compensation paid to their independent contractors each year.
Independent contract work can often be fraudulent, however, and these cases are estimated to cost the government between $6 and $20 billion per year in tax revenue. But the IRS also argues that it's helping to protect employees who are fired from their jobs and then rehired as independent contractors without benefits.
"The main cause of dissention over current application of the law is that it often tends to penalize individuals who wish to be classified as independent contractors and take advantage of tax breaks (as well as the small businesses that depend on them), while it often fails to protect individuals who should be classified as employees and be eligible for benefits," according to Inc. "For example, the IRS would be likely to review the case of a highly paid engineer who markets her services to several companies as an independent contractor and deducts various expenses of doing business. However, the IRS would be unlikely to review the case of a migrant farm worker who is employed by a large producer but, as an independent contractor, makes less than minimum wage and receives no disability or old-age benefits."
Whatever the case, the controversy over independent contract work is nothing new. But as ever more people can do their jobs remotely, this kind of work is on the rise.
AnnaMarie Houlis is a feminist, a freelance journalist and an adventure aficionado with an affinity for impulsive solo travel. She spends her days writing about women’s empowerment from around the world. You can follow her work on her blog, HerReport.org, and follow her journeys on Instagram @her_report, Twitter @herreportand Facebook.