What Is an Independent Contractor?

Independent contractors can do almost any job, from gardeners to graphic designers. What makes independent contractors different from employees is not the job they do, but how they do it.

What Is an Independent Contractor?

Independent contractors (often referred to as "ICs") are workers who are self-employed. They set their own hours, determine where they'll perform the work, and control how they'll get the job done. Unlike employees, who are told what to do and how to do it by their employers, independent contractors can set their own rules. (Of course, the final product has to meet with the client's approval, and independent contractors and clients usually start out with a written agreement or contract that spells out the work to be completed.)

Another difference between employees and ICs is that employees receive wages or salaries subject to withholding taxes like federal income tax. By contrast, independent contractors are responsible for paying their taxes directly to the state and federal government.

Independent contractors are also known as 1099 workers, so named because those who hire them report to the IRS the payments the IC receives, on a form called IRS 1099.

Who Can Be an Independent Contractor?

Independent contractors can engage in nearly any kind of work, but employers can't call just anyone who works for them an independent contractor. Federal and state laws describe the situations in which a worker can properly be classified as an IC. If the worker's situation doesn't fit within the rules, the worker is not an IC, regardless of the employer's wishes.

Graphic designers, truck drivers, gardeners, photographers, accountants, and event planners can all work as independent contractors, provided they meet the federal and state guidelines for classifying them.

Courts and governments use a variety of tests to determine when a worker can be classified as an independent contractor. Workers are generally considered independent contractors when:

• They are paid by the project, not by the hour, week, or month
• They work with their own tools and equipment, not those supplied by the company who hires them
• They are free to perform work for other businesses
• They are free to work at a location and during hours of their choosing (although clients can give independent contractors deadlines for completing the work)
• They can employ subcontractors for all or part of the work (unless their contract with the hiring firm says otherwise)
• They can use their own methods for completing the work, and don't have to follow an employer's instructions for how the work is done.

Some states like California impose more stringent requirements for classifying workers as independent contractors, and lawmakers at the state and federal levels change or add new tests from time to time.

Employees vs. Independent Contractors: What's the Difference?

Let's say there are two event planners, both charged with setting up an annual corporate gathering, including securing a location, hiring the vendors needed, and creating marketing materials to inform the company's employees and business partners about the event.

Event planner No. 1 is required to work at the company's offices from 9:00 a.m. to 5:00 p.m. daily; uses a company computer, phone, and email system; submits vendor selections and costs to management for approval; and provides weekly status reports on the vendors hired, the costs, and the marketing materials delivered.

Event planner No. 2 is given a budget with instructions to secure the location and hire vendors within the budget and to prepare marketing materials. The event planner is also instructed to complete these tasks in the next two months. At the end of that time, the event planner must submit a list of vendors hired, an expense report itemizing the costs, receipts for payments made; and the marketing materials developed.

Although both event planners are doing the same job, event planner No. 1 would be considered an employee because the company has retained most of the control over the means and methods for getting the job done.

While the company gave event planner No. 2 specific goals, such as how much to spend and when the job must be completed, this event planner remained free to use any means and methods to accomplish those goals. A court or government agency would be likely to consider this employer justified in classifying this event planner as an independent contractor.

How Are Independent Contractor Businesses Structured?

Anyone who is self-employed is an IC. Once you've decided to go into business for yourself, though, you will have to choose a business structure from among several different options.

• a sole proprietorship
• a limited liability company (LLC)
• a partnership, or
• a corporation.

Each of these entities has different legal and tax requirements and benefits.

How Independent Contractors Pay Income and Other Taxes

Independent contractors are required to pay income taxes on the profits of their business and a self-employment tax (a required contribution to Social Security and Medicare).

The way you are taxed and the forms you file differ depending on the business entity you've chosen. In general, unless you're drawing a paycheck from your business with taxes already withheld, you'll need to pay estimated quarterly taxes on your income (including the self-employment tax), and file an annual tax return.

Paying Quarterly Taxes

The IRS provides Form 1040 ES, Estimated Tax for Individuals, to help you determine if you are required to pay quarterly taxes and the amount you should pay. Once you've determined the amount of tax you owe, you can send your payment to the IRS by mail or by making your payment electronically on the IRS website.

Filing an Annual Tax Return

Here too, the type of annual tax return you file depends on the way you've structured your business. In general, independent contractors are required to report income or losses from their business on IRS Schedule C, and they report Social Security and Medicare taxes on Schedule SE (Form 1040 or 1040-SR ), Self-Employment Tax. ICs who have formed a corporation file a separate corporate tax return.

Pros and Cons of Working as an Independent Contractor

Earlier we discussed some of the benefits of working as an independent contractor, like setting your own hours and making your own rules. In addition, independent contractors are able to:

• Choose the kind of work they take and the companies they work for
• Set different terms and pay rates for various clients, and
• Own the intellectual property rights to work they create, such as art, music, or software, unless the parties sign a contract that specifies that the works belong to the client company. (Intellectual property rights typically belong to the employer when the work is created by an employee, except in the case of patents, which are owned by the employee.)

On the flip side, independent contractors have the added responsibility for all business decisions they make, including decisions that might have important legal and financial consequences. Independent contractors also don't get these benefits that employees typically enjoy:

• Protection from some laws designed to protect employees, such as employment discrimination
• Company-paid benefits such as pension plans, health insurance, or paid vacations and other time off, and
• Instead of a steady, predictable paycheck, independent contractors can experience peaks and valleys in their earnings.