What is an independent contractor?

An independent contractor is a self-employed person who provides a service and is contracted by a company or individual to perform a specific task. Independent contractors establish a relationship with their client by signing a contract, bypassing the process of establishing the legal and tax relationship necessary for formal employment.

The ease of this relationship—and the tax benefits for companies—make this arrangement popular for part-time, temporary, project-based, and contract roles, allowing the gig economy to flourish.

While working as an independent contractor provides workers with flexibility and control over their schedule, it also results in reduced job security and a higher income tax burden on the individual, not to mention independent contractors are not subject to federal protections and benefits mandates.

Whether you’re looking to become an independent contractor or ready to hire one, it’s important to understand the pros and cons of these types of roles. Let’s look further at what it means to be an independent contractor and how you can ensure you’re abiding by employment and tax law.

Independent contractor overview

Independent contractors—also known as freelancers, gig workers, or 1099s—are not employees. As such, they don’t receive federally mandated employee benefits from clients such as paid time off or retirement, and are not subject to certain aspects of employer control.

This arrangement is popular with companies because it reduces tax burden—contractors must pay their own Social Security and Medicare taxes, known as self-employment tax—but the lack of benefits increases turnover and discourages long-term work relationships.

For freelancers, this arrangement gives freedom and flexibility, but increases income tax burden and doesn’t come with the benefits packages that typical employees enjoy.

Here is a quick breakdown:

• Independent contractors are self-employed workers who set their own schedule, which can provide significant flexibility.
• Independent contractors do not receive benefits such as retirement, health insurance, or paid time off—they must provide this for themselves.
• Self-employed individuals must pay their own Social Security and Medicare taxes and must pay employment taxes quarterly basis.

Examples of independent contractors

Independent contractor is a broad category that can include many different professions. Most independent contractors are hired because they have a special set of skills that they can sell to clients. Others work as independent contractors so they can have a more varied or flexible schedule.

Here are some common professions for independent contractors:

• Doctors and dentists
• Lawyers
• Designers
• Writers
• Photographers
• Real estate agents
• Rideshare and delivery drivers
• Caregivers and nannies
• Fitness instructors and yoga teachers
• Cleaners
• Construction workers
• Electricians, plumbers, and carpenters

Independent contractor vs. employee: Key differences

There are a few key differences between employees and independent contractors.

• Control over work. Independent contractors have a lot more control over how and when they work. If an employer can control when, where, and how a person works, then that person is not an independent contractor.
• Ownership of work. An employee doesn’t retain ownership rights over work created for an employer, whereas a contractor does.
• Employee benefits. Benefits such as retirement, health insurance, and paid time off are provided to employees by their employer, and certain benefits are mandated by federal or state regulations. Independent contractors must seek these benefits on their own. 
• Tax burden. All income is subject to various income taxes, two of which are designated for Social Security and Medicare. Employees are responsible for half of the Social Security and Medicare taxes required for their income, while employers pay the other half. A self-employed individual must pay the entirety of the required Social Security and Medicare taxes.
• Tax forms. Independent contractors and employees fill out different income tax forms at the end of the year when filing their taxes with the IRS. Contractors receive 1099 forms proving their income, whereas employees receive W-2 forms showing the breakdown of income and taxes paid throughout the year. 
• Training and development. Contractors are generally hired for a specific set of skills or expertise. This means that contractors should be considered experts in their field and shouldn’t need much training or onboarding. Employees may need more extensive training or development to complete their role.

If you’re trying to identify whether a role should be classified as an independent contractor or employee, the IRS provides some helpful guidance.

Consider the following questions:

• Behavior: Does the company or worker have control over how a job gets completed?
• Finances: Does the company or worker control how the worker gets paid? Who provides tools? Who controls payment terms?
• Employer-employee relationship: Who provides the worker with benefits? Is there a written contract?

If you’re uncertain as to whether or not you are an independent contractor or employee, the IRS can evaluate the terms and make a judgment. Better yet, you can reach out to a lawyer to get the most clear picture and expert guidance about your situation.

Independent contractor taxes and obligations

Under IRS guidelines, independent contractors can either be sole proprietors or single-member LLCs. As such, they have slightly different tax obligations than employees. 

• Self-employment tax. Independent contractors must pay self-employment taxes, which include the entirety of their contribution to Social Security and Medicare. For traditional employees, this payment is split between employers and employees. 
• Reporting income. A self-employed individual must report their income for federal tax purposes on Schedule C (Form 1040). They will receive a Form 1099-MISC income statement from each client who paid them over $600.
• Business deductions. To lower their taxable income, freelancers can deduct business expenses from their income, including most things that they deem necessary to allow them to perform their job.
• Estimated quarterly taxes. Contractors should pay their estimated taxes quarterly to avoid fines. These payments are reported on Form 1040-ES.
• Sales tax. Some independent contractors will be liable for paying sales tax if they produce or sell taxable goods. 

Advantages and disadvantages of being self-employed

When deciding whether or not you want to be your own boss, it’s important to weigh what’s most important to you when it comes to your work.

Advantages

• Autonomy and flexibility. People who are self-employed get to choose when they work and what methods they use to complete their work. This flexibility can be helpful for people who are caregivers or want to work a non-traditional schedule. Contractors also get to choose which projects they want to take on and which clients they want to work with.
• Potential for higher earnings. Contractors have more flexibility to negotiate their pay rate. As such, they are not subject to the budget of a single employer and can take advantage of fluctuations in the market and/or increased demand for their services.
• Tax deductions. Self-employed individuals get to deduct business expenses from their income for federal tax purposes, reducing their tax burden. Deductions may include expenses for setting up a home office, work supplies, software, subscriptions, business meetings, and more.
• Ability to work for multiple clients simultaneously. Generally, freelancers are contracted on an hourly or project basis and do not work full-time for a single client. This means that they often work with multiple clients at the same time.

Disadvantages

• Lack of employee benefits. Independent contractors will not receive PTO, health insurance, or retirement payments from clients. They must make arrangements for these on their own or receive them through family, a spouse, or an additional W-2 job.
• Tax implications. Working as a contractor comes with the need for managing complex financial situations. Your income may be more sporadic and less traditional than a set salary or hourly wage. You’ll need to save for quarterly taxes and develop an understanding of appropriate business deductions. Many freelancers hire accountants to help them navigate their end-of-year taxes.
• Not eligible for unemployment. One of the benefits traditional employees receive is the ability to apply for unemployment. Contractors are not eligible for unemployment because they are in control of their own employment status.
• More difficult to get loans. Financial institutions view contractors as more financially unstable than traditional employees. If you apply for a loan or mortgage as an independent contractor, the bank will likely want to see additional financial information before considering you. This might mean showing a longer history of income or a higher amount of savings.
• Lack of coworkers. Whether this falls in the advantages or disadvantages is up to the individual person, but it’s an important reminder that freelancers are more likely to work alone and have less interaction with people in their day-to-day. 

What employers should know about hiring independent contractors

Properly classifying employees is critical, for both employer and employee. Because contractors and employees pay different taxes and are managed differently, misclassification can bring liability and penalty upon employers. To avoid this, employers should review guidelines from the IRS and the Department of Labor on classifying employees and contractors.

One of the most important protections contractors and employees can put into place is a formal contractor agreement.

What should be included in an independent contractor agreement?

An independent contractor agreement defines the working relationship between an employer and the contractor. This agreement typically expresses the product or service being provided, the agreed-upon payment schedule, and an expectation of the end result. Since contract work is an outcome-based arrangement that allows the contractor to perform services in the manner they see fit, these agreements allow you to clearly establish that someone is a contractor and not an employee, protecting you from legal claims to the contrary.

An independent contractor agreement is a legal document that should be created and reviewed by a lawyer. It can be customized to your specific needs and the situation, but a robust contractor agreement is essential to prevent misunderstanding and misclassification. We can help you get started, find a LegalZoom-vetted lawyer today.

What are the risks of misclassifying employees?

Misclassifying employees can lead to financial penalties, fines, and audits from the IRS. Beyond opening you to expensive legal liabilities, regularly misclassifying contractors could damage your reputation and make it more difficult to find contractors who want to work with you.

FAQs

How do you become an independent contractor?

Becoming an independent contractor can be as easy as finding your first client.

Independent contractor positions can look different depending on what type of work you want to do, the clients you work with, and how often you’d like to work. There are no special steps to follow other than signing a contract. Freelancers can work as sole proprietors or can register themselves as business owners, such as a single-person LLC. Some businesses must register for a business license depending on their service.

Can an independent contractor deduct business expenses?

Yes! Independent contractors can deduct a variety of business expenses. This might include the following:

• Vehicle mileage
• Client gifts
• Work supplies
• Software
• Technology
• Home office use
• Business travel
• Business meetings (meals, coffee)
• Retirement savings (LLCs only)
• Health insurance premiums
• Equipment

How can independent contractors protect themselves legally?

One of the best ways for an independent contractor to protect themselves is by signing an independent contractor agreement with every client they take on. 

Are Social Security and Medicare taxes covered by self-employment tax?

Yes. Most self-employment tax goes toward Social Security, and the rest goes toward Medicare. Contractors are required to pay the full amount of Social Security and Medicare taxes for their income, while employers must cover half of these burdens for their traditional employees. This is one of the tradeoffs of being an independent contractor.