Independent contractors are professionals hired by individuals (or companies) to perform a service. Each one has different classifications under the IRS, which also means different tax obligations. However, it can sometimes be difficult to make the distinction between an independent contractor and an employee. In this guide, we take a closer look at what it means to be an independent contractor.
Independent Contractors Defined
Independent contractors are self-employed individuals or freelancers operating in an independent trade, profession or business. Some independent contractors operate as sole proprietors, while others operate single-member limited liability companies (LLCs) to manage their businesses.
These individuals might be doctors, electricians, freelance writers, accountants, veterinarians, lawyers, dentists, contractors, artists, auctioneers or subcontractors, according to the IRS. The IRS also states a clear distinction between employees and independent contractors: a person is an independent contractor as long as the payer has the right to direct only the result of the work, not what or how it will be done. This means that the payer only has a say over the final product, not the method in which it’s accomplished.
For instance, if you hire a lawn care service to landscape your yard, you can only control the timeline and the final result of the services. You won’t have control over how the lawn professionals do their job; you’re essentially paying for the outcome — not the methodology.
Independent Contractors vs. Employees
As mentioned earlier, you are an independent contractor if you meet the following three guidelines established by the IRS:
- You’ve built an independent trade or business that generates profit
- Your buyers have control over the final outcome of your work, not the way the work is done
- Your services aren’t controlled by an employer
You’re an employee even if you’re employer gives you the freedom of action to perform certain services. This is because your employee still has the legal right to control the details of how a particular service is performed.
Independent Contractor Taxes
Independent contractors are typically required to pay both self-employment taxes (SE tax) and income taxes. They have to file annual tax returns and pay estimated taxes on a quarterly basis. The SE tax functions as a Social Security and Medicare tax designed specifically for the self-employed, according to the IRS.
These professionals have to file income tax returns if their net earnings from self-employment are $400 or more. Independent contractors can calculate their SE taxes by using Schedule SE on Form 1040. The SE tax rate for 2020 is 15.3%.
The Bottom Line
Independent contractors are self-employed individuals who don’t operate under the traditional employer-employee relationship. The IRS also taxes these professionals differently than employees. These freelancers sell products and services, and they have absolute control over the strategies they use to produce the final product. However, those purchasing the services determine the final result of the product or service.
Tax Planning Tips for Independent Contractors
- Financial advisors can help you with tax planning, income planning, or any other area of finance that might protect your business. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- The IRS mandates that independent contractors or self-employed individuals pay two taxes: self-employment tax and income tax. Therefore, it’s useful to keep track of your income and expenses so you can plan for both taxes. Our income tax calculator can help.
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