An independent contractor is a self-employed individual or business that provides goods or services to another entity under a contract or agreement. Unlike employees, independent contractors have control over how and when they complete their work and are responsible for their own taxes and benefits.
Independent contractor vs. employee
When comparing an independent contractor to an employee, there are significant differences in terms of labor and employment laws, benefits, and taxes.
Independent contractor
Employee
Labor and employment laws
Typically not covered by the same labor and employment laws as employees and therefore don’t have the same statutory protections
Protected under various employment and labor laws, including the Fair Labor Standards Act (FLSA), the main federal law for employment rights in the US, which guarantees minimum wage, overtime pay, and other protections
Benefits
Typically responsible for their own benefits and don’t receive them from any of their employers
Typically eligible for company-provided benefits, which often include health insurance, workers' compensation, unemployment insurance, and paid time off
Tax obligations
Responsible for paying their own self-employment tax, including local, state, and federal tax, as well as both the employee and employer share of Social Security and Medicare taxes.
To offset some of their obligations, contractors can deduct business expenses from their income on their yearly tax return, and may qualify for other tax deductions that further reduce their taxable income.
Have their federal and state income taxes, Social Security, and Medicare taxes withheld from their paychecks by their employers, and they are not responsible for the employer's share of these taxes
Independent contractor vs. self-employed individual
Independent contractors are self-employed, which means they act as their own boss. That’s why you may hear them referred to as sole proprietors, which is another name for an independent contractor (when they do business as an individual).
They can also register as a business entity, like an LLC or a corporation. Many independent contractors go this route to unlock tax advantages, small business loans, and other benefits.
Independent contractor vs. remote worker
Many remote workers are independent contractors, but not all independent contractors are remote workers—even though many of them are location-independent. For individuals who are interested in remote work, becoming an independent contractor is often a viable path toward that goal.
Independent contractor vs. freelancer
Freelancer is another name for an independent contractor. Freelancers are self-employed individuals who work on a contract, often short-term basis, to provide goods or services to other entities.
Independent contractor vs. gig worker
The gig economy has blurred the lines between traditional employment and independent contracting. Gig workers often take on jobs through digital platforms (like ride-sharing or delivery services) that connect them with customers for short-term work. Independent contractors typically have more structured agreements and may work on larger, longer-term projects.
Both gig workers and independent contractors enjoy flexibility in choosing when and how they work, but independent contractors generally have more control over the scope of work and the terms of their contracts.
Gig workers are often hired as independent contractors, but in recent years, misclassification lawsuits centered on gig apps have led to new rules and state laws changing how these types of workers are classified.
Classification of independent contractors
Independent contractor status typically applies to individuals who operate under their own business name, offer services to the public, and have control over how they perform their work.
On the other hand, employee status is generally reserved for those who work under the direction and control of an employer, which includes being subject to the employer's policies and procedures.
Understanding the nuances between these worker statuses helps businesses comply with legal requirements and properly classify workers.
Common law rules
Common law rules help determine the employer-employee relationship and whether a worker should be classified as an independent contractor, subcontractor, or employee. The IRS uses three broad categories to assess this relationship: behavioral control, financial control, and the nature of the relationship.
- Behavioral control examines the extent to which the employer directs the work performed, including how, when, and where the work is done.
- Financial control considers the business aspects of the worker's job, such as who supplies the tools and how the worker is paid.
- The nature of the relationship looks at how the parties perceive their relationship, including the presence of a written contract or the potential for a long-term relationship.
IRS Form SS-8
When an employer is unsure about a worker's classification, the IRS Form SS-8, Worker Classification, can be filed to request an official determination of the worker's employment status.
This form is used by either the employer or the worker to clarify whether the working relationship should be classified as an employer-employee relationship or an independent contractor relationship. By providing detailed information about the working relationship, the employer or worker can request an IRS ruling that determines whether the worker is an independent contractor or an employee, helping to avoid potential misclassification issues.
Misclassification of independent contractors
Employees misclassified as independent contractors pose a significant legal and financial risk for businesses. When workers are misclassified, they miss out on benefits and protections that employees are entitled to, such as minimum wage, overtime pay, and unemployment insurance. Additionally, employers may face legal consequences for failing to meet payroll tax obligations and other employment-related requirements.
Understanding the difference between an employment relationship and an independent contractor relationship is crucial for avoiding these risks.
Penalties for worker misclassification
Businesses with misclassified workers may be subject to severe penalties, including back taxes, fines, and interest. The IRS can impose penalties, or businesses can be sued by the workers themselves.
Pros and cons of hiring independent contractors
Pros of hiring independent contractors
Cons of hiring independent contractors
Cost savings: Employers save on payroll taxes, benefits, and other employee-related expenses such as health insurance and retirement plans
Less control: Employers have less control over how independent contractors perform their work
Flexibility: Independent contractors can be hired on a per-project basis, allowing businesses to scale their workforce according to current needs
Risk of misclassification: Misclassifying employees as independent contractors can lead to significant legal and financial penalties
Specialized skills: Contractors often bring specialized skills and expertise that might not be available in-house
Lack of loyalty: Independent contractors may not be as invested in the company’s success as full-time employees
Less long-term commitment: Businesses can engage contractors for short-term projects without the obligation of providing ongoing employment
Inconsistent availability: Contractors may not always be available when needed, especially if they work with multiple clients
How to hire an independent contractor
Want to hire an independent contractor? The steps below will help you get started.
1. Define your needs
Before hiring an independent contractor, define your project requirements and business needs. Identify the specific skills, experience, and expertise you need for the job. This step helps you narrow down your search so you can find a contractor who will be the right fit for you.
2. Find and vet candidates
Once your needs are defined, start searching for potential contractors. You can find candidates through online job boards, industry networks, or referrals. Vet candidates thoroughly by reviewing their portfolios, checking references, and conducting interviews to assess their qualifications and fit for your project.
3. Do the right paperwork
When you’ve selected a contractor, the right paperwork establishes a clear and legal working relationship. This includes drafting an independent contractor agreement that outlines the scope of work, payment terms, deadlines, and any confidentiality clauses. A written contract not only clarifies expectations but also protects both parties in case of disputes.
Make sure that the contractor also completes the necessary tax forms, such as Form 1099-NEC (or Form 1099-MISC) for reporting their income.
4. Wait for an invoice
After the work is completed, the contractor will submit an invoice for payment. Review the invoice carefully to make sure it aligns with the terms outlined in the contract. Then, process the contractor’s payment promptly to maintain a positive working relationship.
Frequently asked questions about independent contractors
Can an independent contractor work full-time for a single client?
Yes, an independent contractor can work full-time for a single client. However, the contractor needs to maintain autonomy over how they perform their work to avoid being classified as an employee for tax purposes.
How do independent contractors pay taxes?
Independent contractors are responsible for paying their own taxes, including self-employment tax, which covers Social Security and Medicare. As taxpayers, they must file quarterly estimated tax payments to the IRS since taxes are not withheld by an employer. They should also keep detailed records of their income and expenses.
Can an independent contractor transition to a full-time employee?
Yes, an independent contractor can transition to a full-time employee if both the contractor and the client agree to change the working relationship. This transition would involve adjusting the work arrangement to meet the criteria for employee status, including tax withholding and eligibility for employee benefits. The taxpayer’s classification would change accordingly.
Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.