The independent contractor vs. self-employed differences often cause confusion, as the two terms are frequently used interchangeably. While these concepts share many similarities, they aren’t the same. In essence, the self-employed category is the bigger one, and it encompasses independent contractors as well as other types of professionals.

Understanding the independent contractor and self-employment statuses is essential for tax purposes, legal protections, and overall business operations. In this article, we’ll explore what both of these have to offer in terms of work flexibility and potential on the one hand and obligations and responsibilities on the other.

Key Takeaways

• Independent contractors and self-employed professionals share similarities, since contracting falls into the broader self-employment category.
• Contractors are hired by clients to provide services and typically have to follow specific rules defined in their contract.
• Self-employed individuals can do much more than just contract work, like selling goods or subscription services.
• Running a self-employment business can be more challenging, but it offers more room for growth and additional write-off opportunities.

Independent Contractor vs. Self-Employed: What’s the Difference?

The main difference between self-employed professionals and independent contractors is that the former is a broad category that includes the latter. The “self-employed” business category describes anyone who works for themselves to earn a living, which includes contractors, but also other types of professionals.

Meanwhile, independent contractors are self-employed individuals and entities who are paid by others to work on a contract basis. They aren’t traditional W-2 employees on an employer’s payroll and are instead responsible for their own taxes and benefits.

Deciding to become a self-employed professional instead of an employee brings the freedom of determining your own hours, rates, and work style. However, this independence also comes with the drawbacks of running a business, as you have many more administrative tasks to take care of besides providing services or selling goods.

#1. Defining an Independent Contractor

An independent contractor is an individual or a company hired by a client to provide services. A client can be another company, business, or individual who needs specific work done, either only once or periodically.

The main thing that distinguishes independent contractors from W-2 employees is how much control a client has over their work. To prevent worker misclassification, the IRS analyzes various aspects, such as:

• Behavioral control. Does the client control every aspect of the contractor’s work (e.g., location, hours, style) like with a traditional employee?
• Financial control. Does the client only pay the contractor’s rate, or do they provide additional funds, tools, supplies, and more?
• Relationship type. Does the contractor have employee-related responsibilities and benefits written into their contract (e.g., mandatory hours, sick leave, holidays, tax withholding, etc.)?

Independent contractors maintain control over their work and are responsible for their own tools, supplies, taxes, and benefits. They typically have multiple clients with per-project or ongoing relationships.

Notable examples of independent contractors include freelancers in various industries (e.g., writers, developers, and designers), consultants, and gig workers.

#2. Defining Self-Employed

Self-employed individuals are professionals who work for themselves rather than for an employer, without a regular paycheck. The difference between being self-employed and freelancing or doing contract work is that self-employment encompasses the two and also includes other professionals who don’t provide contract-based services.

In addition to being an independent contractor, you’re also a self-employed professional in the eyes of the IRS if you’re a sole proprietor or an LLC owner. You can be a part of a partnership or run a venture on your own, both part-time and full-time.

You can even be an independent contractor as part of your ventures while simultaneously selling goods to customers and employing a team. For example, an electrician can provide services with their own tools and supplies while also selling them. Additionally, you’re also self-employed if you run a coffee shop, are a therapist, create and sell physical items like jewelry, etc.

Ultimately, self-employment means being responsible for every aspect of a business, which includes much more than providing goods or services. It involves obtaining the necessary tools and materials, buying insurance, paying taxes in full, leading a team (if you have one), managing payroll, and so on.

#3. Key Differences in How They Work

One of the key differences between independent contractors and self-employed individuals lies in how much autonomy they have in their work. While both have significantly more freedom compared to traditional employees, the work of independent contractors typically revolves around their agreement with their clients.

They are hired by other people or businesses to deliver specialized services or complete particular projects, and their main goal is to achieve that. On the other hand, being self-employed means running a business that can be much more than doing contract work (e.g., selling a physical product, developing a software solution, managing a team, etc.).

From a tax-obligation standpoint, independent contractors usually receive Form 1099-NEC from clients who pay them more than $600 a year. They use these forms to calculate and file their taxes. Self-employed individuals need to track every dollar their business earns, whether through contract work, sales to customers, or another way.

Also, depending on the state, city, and municipality, independent contractors may not need to formally register and can work using only their Social Security Number. Self-employed professionals running businesses, meanwhile, need to have the correct licenses and operate under specific business names.

Taxes & Financial Responsibilities: What You Need to Know

The differences in taxes and financial responsibilities between independent contractors and self-employed individuals are among the most important to understand. This will help you stay compliant with relevant regulations while maintaining the financial health of your business.

There are some overlaps, since neither type includes W-2 employees who have their taxes withheld by employers and automatically taken out of their paycheck. Tax responsibility falls entirely on the shoulders of a contractor or a self-employed professional.

They are responsible for filing taxes, calculating deductions and expenses, and more. They need to know which income gets reported in what way and when, when their taxes are due (usually quarterly), what business costs can be written off, and so on. Having this knowledge helps maintain the financial health of a self-employed professional and their business.

#1. How Independent Contractors Handle Taxes

Independent contractors handle most of their taxes through Form 1099-NEC. Their tax routine is quite different from that of traditional employees, who wait for Form W-2 to calculate their taxes.

Instead, contractors receive Forms 1099-NEC from every client that pays them more than $600 for their services in a year. However, even if they don’t receive these, they still need to report their income for tax purposes.

Additionally, they are responsible for self-employment tax, which is usually higher than employee tax. That’s because independent contractors need to cover both the employee’s and employer’s share of Social Security and Medicare taxes.

Since contractors don’t have employees to withhold their taxes or pay portions of them automatically, they need to file Form 1040-ES. These are used to pay estimated tax, usually quarterly, and only if you’re expected to owe at least $1,000 in tax for that year.

Lastly, if you’re a sole proprietor, accurate record-keeping is necessary to ensure you file Schedule C (Form 1040), Profit or Loss from Business, correctly.

#2. How Self-Employed Individuals Handle Taxes

Self-employed individuals share some tax duties with independent contractors but often have additional obligations.

For starters, they are responsible for paying self-employment tax and making estimated quarterly payments, just like contractors. If they do contract-based work, they will also receive Forms 1099-NEC and use them to report income.

However, self-employed individuals who do more than contractual work need to track every source of business income. This includes direct sales, revenues from online platforms, and other types of earnings.

If they are sole proprietors and single-member LLCs, self-employed individuals also file Schedule C (Form 1040) and Form 1040-ES. Like contractors, they calculate and pay estimated tax quarterly.

However, different self-employed business structures require different tax forms. For instance, Form 1065 is used for partnerships, while S and C corporations use Form 1120S and Form 1120, respectively.

Each of these structures changes how self-employed individuals should approach their taxes, allowing for diverse and intricate strategies for managing the tax bill. There can also be additional tax-related tasks, such as handling payroll taxes when there are employees or collecting sales taxes when selling goods.

#3. Deductions & Expenses: What Can You Write Off?

One of the biggest benefits of being an independent contractor or self-employed individual is having the ability to write off business expenses and lower taxable income. As a general rule, you can write off things that are necessary to run your specific type of business.

For instance, you can leverage home office deduction as a small business, write off costs for essential equipment or software, basic office supplies, fees associated with professional training, courses, and conferences, business-related travel costs, premiums for insurance, etc.

A big opportunity for tax deduction for both independent contractors and self-employed individuals is the premiums paid for health insurance. Retirement savings options are another great way of saving on taxes. SEP IRA and SIMPLE IRA, as well as self-employed 401(k), all come with tax returns or deductions.

The greater the business that you run, the more opportunities for tax write-offs. Renting offices or storefronts, distributing salaries and giving benefits to employees, and purchasing the necessary materials for creating goods and providing services all represent opportunities for write-offs.

Independent Contractor vs. Self-Employed Difference: Summary

Here’s a concise summary of all the differences between independent contractors and self-employed individuals:

Pros & Cons of Being an Independent Contractor vs. Self-Employed

Deciding between being an independent contractor working on a project-to-project basis or opting for a broader self-employed business comes down to the pros and the cons. Both routes give much more freedom compared to traditional 9-to-5 employment, but they come with additional complexities and risks.

Working as a contractor can be appealing to those who are after simplicity. On the flip side, self-employment offers greater opportunity for control and growth at the cost of more responsibilities and complications.

Let’s explore some of the biggest benefits and drawbacks of these two states of working to help you figure out which one aligns with your goals, needs, and aspirations.

#1. The Perks & Challenges of Being an Independent Contractor

Let’s start with the perks of being an independent contractor:

• It’s simple to set up. You can start and run your business without complex administrative work beforehand.

• The work is flexible. You maintain plenty of control when choosing clients and doing services for them.

• The projects are dynamic. Working with different clients and projects is more interesting than many repetitive jobs.

• You set your own rates. As you gain experience and reputation, you can start charging more per hour and quickly surpass a traditional employee with equivalent competencies.

Now, here are some of the challenges:

• No company-provided benefits. As an independent contractor, you won’t have company health plans, paid sick leave, vacation time, or other benefits.

• Inconsistent income. Both independent contractors’ and self-employed individuals’ salaries can be volatile compared to traditional employment. That can result in increased stress, and it can make budgeting difficult.

• Full tax responsibility. You have to cover the entire self-employment tax yourself.

#2. The Perks & Challenges of Being Self-Employed

Here are the perks of being self-employed:

• Complete control. You control every aspect of your business, including branding, strategies, and management.

• Unmatched growth potential. You can potentially scale your business beyond what an independent contractor alone can do.

• Building an asset. As you grow your business, it becomes a valuable asset that can earn you more money or even be sold down the road.

• Multiple income streams. There’s the potential to expand your business to provide multiple services, sell products, offer subscriptions, and more.

Lastly, let’s see the challenges of self-employment:

• Significant risks and responsibilities. You alone will have to solve the majority of problems and obstacles that your business faces.

• More costs and complexities. Running a business is much more complex than being an employee or even an independent contractor.

• Requires an initial investment. Starting a business typically requires a lot of money, time, or both upfront without guaranteed returns.

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Final Thoughts

Understanding the independent contractor vs. self-employed differences and similarities can help you choose a fulfilling career path that suits your needs. While both offer a much higher degree of autonomy compared to 9-to-5 employment, each comes with distinct benefits and challenges.

As an independent contractor, you can hit the ground running fairly quickly and without much administrative overhead. On the other hand, self-employment offers more potential for expansion but also comes with additional complexities.

Regardless of the business model you go with, it’s vital to ensure accurate record-keeping for tax purposes. If you want to simplify and automate the process, feel free to use our intuitive generators at Paystub.org.

FAQs on Independent Contractors vs. Self-Employed

#1. Is every independent contractor considered self-employed?

Yes, every independent contractor is considered self-employed from the IRS standpoint. This means you’re responsible for finding work, managing your income, and paying self-employment taxes. It’s important to note that self-employed professionals can run other businesses besides being independent contractors, as well as ventures entirely unrelated to providing contract-based services.

#2. Do independent contractors need a business license?

Whether independent contractors need a business license depends on the state, city, and municipality. The states of Washington and Alaska require anyone (independent contractors included) running a business to have a license. In other states, the requirements vary. That’s why it’s critical to check the requirements with relevant local departments.

#3. Can a self-employed person hire employees?

Yes, a self-employed person can hire employees. Whether you’re running a business as a sole proprietor or an LLC, you can hire employees and even other contractors to work for you. However, it’s essential to understand that bringing in employees results in having an additional layer of responsibilities.

#4. What are the biggest tax differences between the two?

Independent contractor vs. self-employed tax differences come down to the disparities in the scale and structure of work. Contractors mainly use Form 1099-NEC for tracking taxable income. Self-employed individuals track all their income streams based on their line of work (e.g., sales, services, contract work, online payments, etc.).