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What Is an Independent Contractor?
An independent contractor is a person or entity contracted to perform work for—or provide services to—another entity as a nonemployee. As a result, independent contractors must pay their own Social Security and Medicare taxes. In addition, the entity is not required to provide the contractor with employment benefits, such as health insurance, that they might otherwise be required to provide were the contractor an employee. The payer must correctly classify each payee as either an independent contractor or employee. Another term for an independent contractor is a freelancer.
Understanding Independent Contractors
Doctors, dentists, veterinarians, lawyers, and many other professionals who provide independent services are classified as independent contractors by the Internal Revenue Service (IRS). However, the category also includes contractors, subcontractors, freelance writers, software designers, auctioneers, actors, musicians, and many others who provide independent services to the general public. Independent contractors have become increasingly prevalent in the rise of what has been dubbed “the gig economy.”
An independent contractor, or freelancer, is a person or entity contracted to perform work for—or provide services to—another entity as a nonemployee.
In the United States independent contractors are considered sole proprietors or single member limited liability companies (LLCs). They must report all their income and expenses on Schedule C of Form 1040 or Schedule E if they have profits or losses from rental properties. Further, they must submit self-employment taxes to the IRS, usually on a quarterly basis using Form 1040-ES.
However, as sole proprietors, independent contractors do not necessarily pay taxes on their gross earnings. Applicable business expenses can reduce their overall tax obligation. The difference between gross earnings and business expenses is the net income, the amount on which taxes are due. As of 2019 independent contractors pay 12.4% in Social Security contributions and 2.9% in Medicare payments on the first $132,900 of their net income, plus 2.9% on their net income in excess of $132,900. Some independent contractors may also have to pay state sales taxes, depending on the product they are producing.
Independent contractors must keep track of their earnings and include every payment received from clients. Clients are legally obliged to issue 1099-Misc forms to their contractors if the amount they paid warrants that expense. If an independent contractor earns more than $599 from a single payer, that payer is required to issue the contractor a 1099 form detailing their earnings for the year.
Independent Contractor vs. Employee
Workers can be classified as either an employee or an independent contractor. When a worker is an independent contractor, the employer can control only the quality or result of the job—not the method through which the work is done. When the worker is an employee, the payer can mandate that the output occur in a particular place and at a certain time or pace. A business owner has more control over the completion of the job.
In return for this control over work specifics, the owner commits to provide the employee with several benefits. These include matching Social Security and Medicare contributions, providing the tools required to complete the project, the potential of employer-sponsored retirement plans such as a 401(k) or IRA, and giving the worker access to a workplace.
In contrast, independent contractors must provide benefits for themselves, including paying both the employee and employer portions of Social Security and Medicare payments, among other expenses. The independent contractor must still meet the payer’s quality standard and time frame while producing the product. Independent contractors often work for employers who are physically far removed from their location. As such, they must be ready to compete on the global market for work. Being an independent contractor has downsides, as they have no access to unemployment insurance or workers’ compensation payments.