Are you in the process of hiring independent contractors for your business? If so, you might be seeking clarification on the differences between independent contractors and self-employed individuals. Understanding these distinctions is crucial, as they have implications for taxes and insurance. Before finalizing any arrangements with independent contractors, let's clear up the confusion surrounding self-employed vs. contractor.

Defining an Independent Contractor

An independent contractor is an individual who provides services to another entity, whether an individual or a company, as a non-employee. As the term implies, independent contractors have a significant degree of freedom in their work compared to employees.

US labor law provides three key categories to differentiate between employees and independent contractors:

Behavioral Control

Is an independent contractor considered self-employed? To some extent, yes. Like self-employed individuals, independent contractors cannot be micromanaged to the same extent as employees. They operate as non-employees, which means there is less control over their work compared to employees.

Independent contractors determine their own working hours, location, equipment, tools, schedule, work methods, and more. You provide your requirements and project deadlines, and the contractor decides the rest. They have control over how and when they complete the work.

Financial Control

Independent contractors offer their services as non-employees and are solely responsible for the business aspects of their work. In terms of working style, the difference between self-employed and independent contractors is not significant.

These individuals independently decide where and how to invest their business income, whether in training, education, tools, or equipment.

Type of Relationship

Employers should be aware of the type of relationship typically established with independent contractors. Independent contractors are typically hired for a specific period to complete a project. For example, you might hire an independent contractor who is a graphic designer to enhance your social media campaign. This engagement is a one-time arrangement for a defined period, unlike employees who have long-term commitments to a company.

Why Worker Legal Status Matters

Are employees distinct from independent contractors? Are independent contractors considered self-employed? These questions must be answered before you hire independent contractors or employees for your business.

Why is this important?

Because the legal status of a worker affects how you handle their taxation, influencing not only tax deductions but also aspects like the employer-worker relationship, the need for contracts, the degree of control, and more.

Additionally, understanding a worker's legal status helps prevent misclassification, which could lead to penalties if discovered during an audit.

Independent Contractor vs. Self-Employed

Before delving into the main differences between contractors and self-employed individuals, let's provide a clear explanation of whether an individual is self-employed or an independent contractor.

To put it simply, being an independent contractor is a form of self-employment.

Is an independent contractor considered self-employed? Yes. Independent contractors are self-employed individuals who earn income but do not work as employees. For example, the owner of a convenience store is self-employed, as is a freelance graphic designer.

However, is self-employment the same as being an independent contractor? No. The difference between self-employed and independent contractors lies here. While an independent contractor is a type of self-employed individual, not all self-employed individuals are independent contractors.

Here's an example to illustrate:

Imagine hiring a freelance artist to create a custom painting for your new office. This artist is an independent contractor working for you, the client. However, if the same artist creates different paintings for display in galleries without specific clients in mind, they are not functioning as independent contractors. In both cases, the artist is self-employed.

In summary, an independent contractor is a type of self-employed individual, but not all self-employed individuals are independent contractors.

Here are some additional categories that further clarify whether self-employment is the same as being an independent contractor:

Business Structure

Both independent contractors and self-employed individuals typically operate as sole proprietors in terms of business structure. By default, their business structure is a sole proprietorship. However, self-employed individuals can establish different business structures like partnerships, limited liability companies, corporations, etc. Independent contractors, on the other hand, primarily engage in contractual work.

Taxes and Tax Deductions

Taxes for self-employed independent contractors must be paid by the contractors themselves, unlike employees. Employees have taxes automatically deducted from their paychecks by their employers, making tax filing and payment relatively straightforward. However, self-employed individuals, including independent contractors, are responsible for paying their own taxes.

Regarding taxes and deductions, are independent contractors the same as self-employed individuals? Yes. Self-employed individuals, including independent contractors, must pay Social Security and Medicare taxes, income tax, and insurance on their own. Employers must provide independent contractors with a 1099-MISC form to report the total payments made to them. So, in terms of taxation, is a 1099 considered self-employed? Yes.

In summary, here's a brief overview of taxes for self-employed individuals, including independent contractors:

• Self-Employment Tax: Self-employed individuals must pay 15.3% of their annual income as Social Security and Medicare tax.
• Additional Medicare Tax: If a self-employed person's income exceeds a certain threshold, they may be subject to an additional 0.9% tax. For single filers, the threshold is $200,000.
• Federal Income Tax: This tax is based on the self-employed individual's income and determines the tax rate.

For tax purposes, the IRS treats independent contractors as self-employed individuals, so tax deductions are the same for both.

There are various tax deductions available to self-employed individuals, which can help reduce their self-employment taxes. These deductions should be claimed for legitimate business expenses. Examples of deductions include advertising costs, business setup expenses, office supplies, home office expenses (if applicable), licenses and education, legal expenses, insurance (such as health and business insurance), and travel expenses.

• Insurance

Insurance is essential for self-employed individuals, including independent contractors. However, the specific types of insurance required may vary based on the nature of the self-employed individual's business. For instance, freelance graphic designers may prioritize insurance for their equipment, while independent contractors working on-site may require different coverage. If self-employed individuals have employees, workers' compensation insurance may be mandatory. Other insurance options include professional liability insurance, general liability insurance, commercial auto insurance, and more, depending on the individual's circumstances.

• Licensing

Licensing requirements vary from state to state and depend on the type of work performed by self-employed individuals, including independent contractors. For example, food services, broadcasting, beauty services, construction, electrical work, plumbing, and the retail of controlled substances often require licenses. However, consulting, writing, web development, app development, handicraft creation, graphic design, and similar activities may not require licensing. The rules for licensing are not affected by a worker's employment status, and they remain consistent for independent contractors, freelancers, sole proprietors, and self-employed individuals.

Is an Independent Contractor Self-Employed?

Questions about the relationship between self-employed individuals and independent contractors can be somewhat confusing. For example, is an independent contractor the same as a self-employed individual? Are independent contractors considered self-employed?

Here's a straightforward answer to these questions:

Independent contractors are a type of self-employed individual. However, not all self-employed individuals are independent contractors. To illustrate:

Example 1: Consider an individual working as a graphic designer who collaborates with multiple brands across different industries, such as technology, fashion, and e-commerce. This individual operates as an independent contractor and is self-employed. In this case, the graphic designer takes on projects with specific clients but remains independent.

Example 2: Imagine an individual who works as a fashion designer without specific contractual relationships. This person handles all aspects of their business, from design and creation to warehousing and shipping, as a sole proprietor. This type of work, which lacks contractual relationships, is more appropriately classified as a small business.

The key distinction between these examples is that the graphic designer in the first case has contractual relationships with various brands, while the fashion designer in the second case operates a small business without such relationships.

It's worth noting that an independent contractor, who is a self-employed individual, can also be an employee in certain situations. For instance, consider an IT manager employed by a company who also provides web development services to local businesses. In this scenario, the IT manager serves as both an employee and an independent contractor.

In conclusion, while independent contractors are a type of self-employed individual, not all self-employed individuals are independent contractors. Understanding these distinctions is essential for correctly categorizing workers and managing tax and insurance obligations.