Independent Contractor: Definition, How Taxes Work, and Example

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what is an independent contractor

This lowers their taxable income and thus reduces their tax bill at the end of the year. As a business owner, you might need to hire a worker at some point or another. And depending on your type of business, you might need to hire employees, independent contractors, or both to get the job done. Common law principles further define independent contractor status by method of compensation. If a person is on an employer’s payroll and receives a steady paycheck, clearly that the person is an employee rather than an independent contractor. Employer misclassification of employees as independent contractors either inadvertently or to avoid taxation and regulation, is widespread.

How Do You Pay an Independent Contractor?

You pay an independent contractor just like you would pay any freelancer either by the hour, by the project, or by a flat fee. You can pay an independent contractor by check, Venmo, PayPal, or cash.

Most jurisdictions do not require a business license to become an independent contractor. However, some US state laws, such as Washington’s, require all independent contractors to register business licenses. According to the latest gig economy statistics, 78% of gig workers say they’re happier than traditional employees, and 68% say they’re healthier. When a worker is an independent contractor, the hiring party is not required to make any of these payments. Hiring someone to complete that small project you’ve needed done for ages?

Advantages and disadvantages of independent contracting

You can pay an independent contractor by check, Venmo, PayPal, or cash. They aren’t eligible for unemployment insurance or workers’ compensation. They have complete control over building their business, from hiring and firing to choosing clients. Unlike employees who have a set annual salary, there’s no limit on how much money they can earn.

Self-employment taxes can take a big bite out of your income—but you can take steps to minimize the impact. It looks at the dependence of the worker on the business for which he or she works. If a person gains a large portion of their salary from that business, chances are that person qualifies as an employee. To prevent any unwanted surprises, it is essential to define the exact business relationship between you and your employer prior to beginning work. A nonexclusive sales representative agreement allows you to hire several independent sales reps to sell your company’s products. As a business owner, you have many options for paying yourself, but each comes with tax implications.

How to get paid as an independent contractor

If you have control over the project, the worker might be an employee. If you can’t control the work, the worker is more likely a contractor. You need to be familiar with how to create a solid work-for-hire agreement. Consultants provide specialized expert independent contractor advice that helps clients significantly improve their businesses. See what a standard consulting contract contains to decide whether you feel comfortable drafting one yourself. The extent to which services are integral to the employer’s business.

The distinction between independent contractors and employees is not always clear, and continues to evolve. Other companies, for example in the freight transport industry, specify the schedule for the independent contractor, require purchase of vehicles from the company and prohibit work for other companies. Employers must treat 1099 employees just like independent contractors, including freedom from managerial control, the ability to set work hours, and more.

Employee vs. Independent Contractor: Differences You Need to Know

Misclassification of personnel is a significant issue in the US, and infractions can severely punish employers. Independent contractors provide businesses with flexibility when it comes to staffing.

Governments are always on the lookout for companies misclassifying employees as contractors. The pay might not be that high initially, and you will need to give a cut to the service provider, but these platforms are still a good way for connecting with clients and building your portfolio. Although not essential, a business name other than your full legal name earns professional credibility and is a great first step toward creating a brand identity. Strong brand identity will come in handy when creating a website, social media account, and everything else you’ll need to promote your services and attract clients. Depending on your line of work and location, you may need to obtain a business license before providing services as a contractor.

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