If you’re thinking of ditching the nine to five job to work for yourself, you’re not alone. According to the Department of Labor, nearly one in 10 Americans is an independent contractor.
But before you hand in your two-weeks notice, you need to understand the importance of your employment status.
You may be asking yourself, “as long as I get the work done, and get paid does it really matter?” The answer--yes it does!
There are different tax and insurance implications based on your employer-employee relationship, so establishing a work status is very important.
Self-employed vs Independent Contractor: What’s the difference?
According to the IRS, “an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”
An independent contractor can be anyone to provides services to the general public and who does not operate within an employer-employee relationship. Some examples include:
- Doctors in a private practice
- Lawyers, bookkeepers, accountants
- IT, web designers, programmers
Does self-employed mean independent contractor?
This is where it gets tricky, in almost all cases, an independent contractor is self-employed, but not everyone who is self-employed is an independent contractor.
Independent contractors often work for limited time periods according to the terms of a contract. The contract might revolve around the completion of a project or a duration of time, such as a six-month or one-year contract.
Because of the limited scope of the time commitment, an independent contractor is considered to be self-employed.
Business owners are responsible for providing Independent contractors with a 1099-MISC form instead of a W-2, showing the total income paid to the independent contractor. Since independent contractors are not employees the contractor is responsible for paying employment taxes, income taxes, social security, and insurance.
On the other hand, A self-employed worker might qualify as an independent contractor or they might be a merchant, meaning they don’t work according to a contract but rather sells goods or services.
Self-employed workers are usually hired by a company to carry out a certain service. They work for themselves in a variety of occupations or trades rather than working for a certain employer. Examples can include lawyers, investors, insurance agents, salespeople, and doctors.
Is a business entity needed?
Choosing to incorporate as a business entity is often optional, but it can provide benefits to a self-employed person or to someone working as an independent contractor. Contrary to popular belief, the tax treatment for business-related expenses often isn’t different whether the contractor is self-employed or incorporated as a business entity.
Business-related expenses can usually be deducted either way, although the tax treatment may vary depending on the type of deduction and the type of business entity you choose.
Among the most important distinctions is that by forming a business you establish a separate legal entity for your business. This can help protect your personal assets from business-related liabilities that can arise from claims or lawsuits. This is why many new business owners choose to form an LLC.
Do independent contractors need a license?
State or local licensing may be required depending on the type of work you do but this requirement isn’t usually affected by whether you are self-employed, an independent contractor, an employee, or have incorporated your business.
In the insurance industry, for example, states require anyone who binds coverage to be licensed for the state, regardless of whether they work for themselves or are a full-time employee of a company. Requirements may also be location-based. For example, In Washington, all persons who conduct business are required to have a license, while other states require only certain professionals like doctors, teachers, or attorneys to have a license.
What types of insurance do I need?
As a self-employed person or an independent contractor, your insurance needs will vary based on the type of work you do, what equipment you have, and the types of risks your business might have.
Certain types of insurance may be required by law, depending on the business you do, such as Commercial Auto insurance or Workers Compensation, while other types of insurance may be required to fulfill contract requirements, like General Liability insurance or Professional Liability.
Even if you operate your business out of your home, commercial insurance is still important. Most home owner’s or renter’s insurance policies will not cover any claims associated with property or equipment used for business purposes. Therefore, at a minimum, it’s in your best interest to have Commercial Property insurance.
Special tax considerations
As a self-employed individual, you are responsible for paying your own FICA taxes. In most employer-employee relationships, the employer pays half of your FICA taxes while you pay the other half as a payroll deduction.
If there is no employer, you are responsible for the entire FICA tax liability. Additionally, most employers automatically deduct federal and state taxes according to the W-4 you complete when hired.
If you are self-employed, there are usually no taxes taken out of your compensation and you’re responsible for making quarterly payments based on an estimate of your tax liability.
The key takeaway
Ultimately, being an independent contractor or a self-employed worker can be very rewarding, but it’s not a decision to jump into lightly. It’s important to weigh all the pros and cons of working independently. With these tips in mind, you’ll be able to make an informed decision about what’s best for your future. If you still have questions, make sure you reach out to an HR expert or legal advisor.
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