Independent Contractor: Definition and Examples
Being an independent contractor comes with a variety of benefits, including flexibility, autonomy and tax deductions for business expenses. However, there are some potential drawbacks about being self-employed to consider too. In this article, we define what an independent contractor is and list examples, as well as explore the pros and cons of this type of work.
What is an independent contractor?
An independent contractor provides goods, labor or services to another individual or organization. An independent contractor is not employed by a business—instead, they work with a business as a third party. Independent contractors typically do not receive the same rights afforded to employees and are responsible for their own retirement plans, insurance and other benefits.
When you work as an independent contractor, you are an individual entity. There are many benefits to working for yourself in this way. You can set your own hours, rates and availability. You are, however, responsible for managing your own payment and taxes. Also, you likely won't have some of the protections that traditional employees receive through labor laws.
Here are some examples of professions that frequently work as independent contractors:
Related: 17 of the Best Self-Employed Jobs
Differences between being an independent contractor and an employee
When you are an independent contractor, you work for yourself. Employees, on the other hand, work for an organization and are often required to follow guidelines laid out by the company. There are many areas where these two roles differ, including:
Hiring practices: Employees typically complete an application and interview with the company. An independent contractor communicates directly with a manager for a project and submits a competitive bid to get hired.
Benefits and incentives: Employees typically have a compensation package that includes health insurance, a retirement plan and paid time off. Independent contractors are not afforded these benefits, so they need to account for these extra expenses by incorporating the costs into the rates they charge customers.
Scheduling and time: Many full-time employees work a standard 40-hour workweek, for example, Monday to Friday, 9 a.m. to 5 p.m. As an independent contractor, you often set your own schedule and decide how many hours you will work.
Training and development: Most employers provide training for employees, whether it’s on-the-job training or developing new skills. Independent contractors need to arrange for their own training and cover the costs.
Pros of becoming an independent contractor
Becoming an independent contractor is a great way to grow your business without the constraints of traditional employment. Here are some benefits that a career as an independent contractor can offer.
Be your own boss
As an independent contractor, you can define all aspects of your business. You decide who you work with and who you work for. The people who pay you are your clients, not employers. As a result, you can complete your work as you see fit to some extent.
Earn more income
Independent contractors can set their own prices for their services. If you put a high value on your services and market yourself correctly, it is possible to earn more as an independent contractor than as an employee.
As an independent contractor, your contributions to health insurance and a retirement plan are tax-deductible, lowering your overall tax bill.
Drawbacks of becoming an independent contractor
While you’re afforded autonomy and freedom as an independent contractor, you may also experience some challenges, such as:
When you're a full-time employee, your employer automatically withholds federal taxes for Medicare and Social Security, as well as any applicable state and local taxes. When you're an independent contractor, you have to handle the tax planning and processing on your own. If you choose to hire a tax professional, it will increase your business costs.
Lack of a steady paycheck
Most employees earn a consistent income, whereas independent contractors must constantly search for work to maintain a steady business. This means that you're responsible for advertising, marketing and development.
Difficulty taking time off
Independent contractors get paid only for the work they do. Without paid time off, if you don't work, you don't earn income. As a result, it can be difficult for independent contractors to take time off from work.
No federal benefits
As an independent contractor, you aren't afforded federal benefits. If something happens to you on the job and you can't perform your duties, you may have to rely on your savings. You also likely won’t have access to unemployment benefits if your workflow is reduced.
How to pay your taxes as an independent contractor
Tax season can be complicated for independent contractors. In most instances, you'll be a 1099 independent contractor. This means that your clients will give you a 1099-Misc document at the end of the year showing your annual earnings and compensation. Unlike traditional employment, you're responsible for paying your own taxes and need to understand your business’ tax obligations. Fortunately, you can avoid tax issues at the end of the year by following a few simple tips.
Set aside some money
Every time you earn income, you need to set aside some money to pay your taxes. To be on the safe side, this should typically be about 30% of your gross earnings. This will depend on the amount of income you make in a year, as your federal, state and local taxes will vary.
Understand self-employment tax
You might have noticed when you get a paycheck from an employer that you have deductions for Medicare and Social Security. These government programs are all paid for by employed individuals in the United States. In a traditional employer-employee relationship, you're responsible for paying 7.65% of your income to these programs and your employer matches it with an additional 7.65%.
As an independent contractor, you're considered by the federal government to be both an employer and an employee. This means that your self-employment tax is 15.3%. This amount goes on top of your income tax bracket. When you do your taxes, you can deduct half of this, or 7.65%, from your taxable income, but you're still responsible for paying 15.3%.
Take advantage of deductions and tax breaks
A 1099 independent contractor should take advantage of all the tax breaks afforded to them that employees don't receive. This includes:
Credit card debt: You should avoid credit card debt at all costs, but if you accrue some during the year, you can deduct this interest from your taxable income to lower your overall tax bill.
Use of a vehicle: If you drive to clients to perform your services, keep a log of your mileage. You can deduct 58 cents per mile from your taxable income.
Gifts: If you buy your clients gifts or entertain them for business purposes, you can deduct a portion of these expenses.
Training and classes: Continuing education courses, training classes and university schooling are all tax-deductible expenses.
Business travel: Whether you're a travel blogger who flies around the world or you need to meet a client and it requires a plane ticket, you can deduct the entirety of the cost.
Retirement savings: Take advantage of a traditional individual retirement account (IRA), a solo 401(k) or a simplified employee pension (SEP) IRA to lower your taxes. These allow you to contribute up to $5,500 to an IRA, $19,000 to a solo 401(k) or $56,000 to a SEP IRA.
Health insurance: Whether you have a traditional health insurance policy or a health savings account (HSA), you can deduct the premiums or contributions.
Equipment and supplies: Everything you buy for business purposes is tax-deductible. This can be big purchases, such as a computer or a vehicle, or smaller purchases, such as paper and staples.
Home office deduction: If you use a portion of your home to conduct business, you can write that off on your taxes. The IRS has specific guidelines and formulas, but it's an easy way to take money off of your tax bill.
Doing your taxes as an independent contractor is tricky, so before you decide to assume all the work yourself, consult a tax professional. These individuals are trained to handle the tax issues and deductions independent contractors encounter.
Becoming an independent contractor has many benefits as well as challenges. Your area of expertise, work ethic and need for work-life balance all play an integral role in whether this career option is right for you.
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