There are a variety of professions that can be done by independent contractors. Any professional that offers their services to the general public can be an independent contractor. These professions can include doctors, dentists, accountants, web developers, speech therapists, and countless others.
There are some differences between independent contractors and employees. To be classified as an independent contractor, the paying company has the right to control only the result of the work, but not always how or when it will be done.
An independent contractor is a self-employed individual. Independent contractors pay self-employment taxes rather than taxes being taken out by the payer. An employee performs services that can be controlled by the employer.
What is an Independent Contractor Agreement?
An independent contractor agreement is a written contract that outlines the terms of the independent contractor's work. It details the obligations, scope, and deadlines of the work that will be completed. It solidifies that the client and contractor are not in an employment relationship.
This agreement describes expectations so there is no confusion about responsibilities of both parties. This can confirm what is expected with regards to workers' classification, payment, and taxes. It is important because it establishes a worker's status for the Internal Revenue Services' tax purposes. Independent contractors have different legal obligations and rights than those of employees.
Employee vs. Independent Contractor
An employee is someone who is on a company's payroll and receives a salary and benefits in exchange for working.
An independent contractor is an individual who does not receive employee benefits, and are solely paid for their work completed.
On the company's end, it is important for the worker to be correctly classified. If not, it can result in back taxes, fines, and even legal disputes.
An independent contractor is a self-employed individual and may be a sole proprietor, or even have an incorporated business. Their business is built around the specialized services they provide. It is also common for independent contractors to have a business name, and work with multiple companies and clients at the same time.
A relationship with an independent contractor can be viewed as a business-to-business relationship. A company might find that they treat independent contractors as employees, but it is important to remember they are legally different.
Employees receive training regarding their job's duties. However, independent contractors bring their specialized skills and expertise to the job for which they are hired. It is efficient for both parties in many ways. Clients don't need to provide contractors with training, which saves them time, resources, and money. Independent contractors can complete a job they are specialized in. Independent contractors are a good solution for irregular business needs.
You can find independent contractors in every industry in the world, and most demonstrate highly specialized skills. Many independent contractors report finding work because they are offering a particular skill that requires special training, certification, or education.
Remember, because independent contractors are running their own businesses, they need to sell and market their services. Just because they have a long-term contract with you doesn’t mean they aren’t allowed to take on additional work for other clients as well.
A traditional employee's job might require the employee to complete a wide variety of duties and tasks. An independent contractor is only responsible for jobs that are outlined in their contract. Clearly outlined tasks and expectations provide the foundation for a good working relationship. The independent contractor needs a clear outline of expectations for a given job, not only for high quality work but also to maintain a good relationship with their employer.
Independent contractors don't work for a specific salary. They submit invoices for their work completed. Payment is discussed, determined, and agreed upon in the contract terms. A payment amount is decided, and then the invoice is paid. Independent contractors might have a standard billing rate for their services. Their rate may also vary depending on what type of work they do, and what each job entails. The client or payer must communicate how and when the independent contractor will invoice, along with when they will receive payment.
There are financial benefits for both the independent contractor and client. The business that is hiring independent contractors doesn't have to provide traditional employee benefits, such as health insurance or retirement plans. Independent contractors are generally compensated at a higher rate because the company doesn't need to provide traditional benefits.
Independent contractors do not have the same legal protections that traditional employees do. They do not have unemployment, anti-discrimination, and workers' compensation, though it is good practice to include basic insurance requirements in contracts.
Independent contractors are their own business entities, and because of this, a client cannot determine contractors' exact work hours. The contractor is solely responsible for fulfilling the work agreement. They have the freedom to work when they want and for how long they want and are in control of their own hours.
Independent contractors might have their own tools, employees, or subcontractors to help them complete assigned tasks. This is something that should be discussed during the initial discussions for a contract. A client can directly ask the independent contractor if they use additional work resources. If so, it should be outlined in the contract. An independent contractor that uses extra resources is responsible for the tax responsibilities. This includes tax deductions, filing, and reporting tax information for these workers.
Advantages of being an Independent Contractor
Independent contractors are their own bosses. They enjoy all the rewards of working for themselves, as well as the risks. They are able to work when and where they please. They have the flexibility to work as little or as much as needed.
Independent contractors have control over their gross income. How much money they make is directly equated to the quantity and quality of the work they complete. This is not always the case for employees. When an independent contractor wants a raise, they don't have to ask for one, they simply raise the amount they charge for their work.
Most employees work for a single employer or company, and depend on that company for their livelihood. When hiring and firing decisions are made, it can greatly impact the employees. Independent contractors don't always have this impact because they often work for multiple companies.
Make More Money
Independent contractors often make more money than full-time employees in someone's business. They are often paid more than full-time employees who perform similar services. Hiring companies are able to pay independent contractors more because they don't have to pay social security tax or unemployment insurance. They don't need to provide workers' compensation insurance, or traditional benefits such as health insurance and paid sick leave.
Lower Income Tax Withholding
Being an independent contractor provides tax benefits that may be unavailable to employees. When you are an independent contractor, no federal or state taxes are withheld from your paychecks. Whereas these same taxes are withheld for employees. Because these taxes are not withheld from independent contractors' paychecks, they have to pay taxes directly to the IRS four times a year. This means independent contractors are able to hold onto their money longer before having to pay taxes. They also have the freedom to decide how much estimated tax to pay, keeping in mind the penalties of underpaying. These factors give independent contractors more control over the money that they earn in many cases.
Independent contractors are also able to take advantage of business-related tax deductions that are unavailable to employees. They are able to deduct from their taxable income any necessary business expenses. However, their deductions must be a reasonable amount and ordinarily incurred by similar businesses. Some examples of business expenses are office expenses, travel expenses, meal expenses, equipment, insurance, and much more.
Because of the tax benefits for independent contractors, they often pay less tax than employees with similar incomes.
Disadvantages of Being an Independent Contractor
While there are many benefits to being an independent contractor, there are also disadvantages.
Little to No Job Security
Employees are paid even when their employer's business is slow or having a difficult time. However, this is not true for independent contractors. If they don't have business coming in, they aren't making money. This could be a reason many independent contractors work for several companies at a given time.
Most employers provide their employees with benefits. These benefits can include health insurance, paid vacation time, and paid sick leave. Some employers even provide retirement benefits and bonuses.
Unfortunately, an independent contractor doesn't receive the same benefits. They have to pay for their own health insurance. Paying for private health insurance is often offered at a higher rate than employers have to pay. If they want to take time off for vacations or illness, it comes with no pay. If they aren't able to pay for these things, then they may simply have to go without.
Risk of not Getting Paid
Unless you're already contracting with a firm that covers this risk (like Talentcrowd, of course), an independent contractor sometimes runs the risk of simply not getting paid by a company. After completing the work they have been hired for, they will invoice the company or client with the amount of compensation agreed upon. Unfortunately, some companies and clients fail to pay the independent contractor. This requires the independent contractor to consistently remind the company or client about payment until they have been paid.
Independent Contractor Taxes
If you are a self-employed individual or a freelancer, you are getting paid as an independent contractor. Someone pays you to perform personal services or deliver a product, but has no control over the process. Because of this, independent contractors are responsible for their own taxes.
Employees usually get paid regularly, on a weekly, biweekly, semi-monthly, or monthly basis. A self-employed individual is in charge of coming up with a payment agreement on payment between them and the payer. This agreement will state when you will get paid and how the transaction will happen.
Payments for those who participate in self-employment are not considered a salary or wages for tax purposes because the payer does not deduct taxes. That means that no federal income taxes, social security taxes, or Medicare taxes are taken out before independent contractors receive payment.
When tax season comes, the payer is required to send anyone with independent contractor status a 1099-MISC tax form. This form reports all of the income that they have paid the independent contractor in the previous calendar year. This 1099 form is the equivalent of an employee W-2 form. Most contractors work for multiple businesses and clients, and therefore should receive multiple copies of a 1099 form.
The IRS looks at independent contractor status as self-employed individuals. That means that the contractor is subject to a different set of tax payment and filing rules than those of traditional employees.
As an independent contractor, you will have to file a tax return with the IRS if your net income from self-employment is $400 or more. You will also submit a form of your net income and business losses.
Those with independent contractor status have to pay a self-employment tax that covers the amounts they owe for social security and medicare taxes for the year.
Deductions are expenses that can lower your taxable income for the given year. Contractors are able to claim them as business expenses on their taxes. Some examples of tax deductions are advertising costs, rent payments, equipment purchases, business insurance, and legal expenses, just to name a few.
Contractors are also able to claim a deduction for their health insurance premiums they have to pay out of pocket. This can include premiums paid for medical, dental, and long-term care insurance. They are also able to deduct the costs of their spouse's and children's health insurance. However, they are unable to deduct premiums for health insurance if they have access to a spouse's insurance plan.
One more deduction that contractors can make is personal expenses. This can include mortgage interest paid, interest paid to student loans, and real estate taxes. Contributing to a self-employed retirement plan or a traditional IRA can also be a tax benefit for contractors.
Summary of Taxes
The tax rules for independent contractors might seem overwhelming, but they ensure that the contractor is paying an appropriate amount in taxes. The tax rules are different from that of a traditional employee, but they are not more complicated. Once a contractor is familiar with the basics of tax rules, they are able to file their taxes easily.
**Talentcrowd and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors for advice based on its particular circumstances.**
Examples of an Independent Contractor
Here are some possible examples of independent contractors if the employment status is still unclear:
An auto mechanic who is self-employed. They have a station license, and a resale license, and buy the parts for repairs. They set their own prices and collect payments from customers. They own their own shop from a third party.
A piano instructor who chooses their own music scores to teach, find, and rent their own facilities. They also supply their own instruments, and music sheets, collect fees from customers and are able to hire assistants.
An accountant who has their own office space. They advertise and charge clients by the hour. They can also be paid an annual retainer. They hire a substitute to do their work if needed.
A baker who owns or rents a space, advertises their services to the public, and supplies all of the tools, equipment, and supplies necessary to make menu items. They also set the price for their products and collect money from customers.
These are all professions that people can also work as employees. However, being an independent contractor is always an option. Independent contractors must set themselves apart from traditional employees by working as a self-employed person.
So What is an Independent Contractor?
Independent Contractors are self-employed workers who are responsible for their own work, supplies, and taxes. They are many benefits to being an independent contractor, such as added freedom, potential for higher pay, and fewer income taxes. There are also disadvantages, such as a risk of not getting paid, lack of traditional benefits from the employer, and no job security.
The employment relationship between a contractor and payer is crucial for both parties to benefit when completing business operations with independent contractors. A clearly outlined contract that includes how, when, and the amount of payment that will be received is essential, as well as expectations of the work to be completed.
Independent contractors might include freelance writers, graphic designers, small business owners, real estate agents, and beyond. You need to consider all aspects of what an independent contractor entails to make sure it is the right fit for you, whether you are a skilled professional or employer.