Glossary of Human Resources Management and Employee Benefit Terms
An independent contractor is a worker who is under contract to provide services for an organization but who is not an employee there.
The purpose of hiring an independent contractor vs. an employee is to receive a service on a temporary basis and/or to avoid the added expenses (benefits, taxes, etc.) of hiring an employee.
An independent contractor can perform any kind of work for an organization. Some common professions for independent contractors include:
Real estate agent
Customer support agent
When comparing independent contractors vs. employees, there are some differences between the two.
Are under the supervision of their employer
Are covered by employment and labor laws (FLSA)
Report taxes on the IRS W-2 form
Report for state unemployment insurance (SUI)
Are not supervised by an employer
Are not covered by employment and labor laws (FLSA)
Are paid either hourly, daily, or weekly, but the total amount is due via invoice when work is completed
Have control over their schedule and day-to-day work
Are not generally offered benefits from the hiring employer
Report taxes on Form 1040 or Schedule C Form 1040 (see below)
Do not report for state unemployment insurance
Being their own boss. While an organization hires a contractor to do work for them, the contractor has all control over when and how the work is performed.
Not being dependent on a single company for their paycheck. Contractors may work for multiple companies at a time and can decide for themselves how much work they take on and how much they charge for their services.
The potential to pay less in taxes. This is not a guarantee, but contractors can take advantage of business-related tax deductions for necessary business expenses.
Job, paycheck, and debt security. If a contractor doesn’t secure work, they don’t get paid. If a client doesn’t pay, the contractor has little recourse, and if debts rack up, contractors are liable.
Employer-provided benefits. Health insurance, retirement benefits, bonuses, paid vacation and sick time, profit sharing are generally not offered to independent contractors. However, contractors may be qualified for a self-employed health insurance deduction.
State and federal benefits. This includes unemployment insurance and workers’ compensation.
Labor law protections. Unfair exploitation and discrimination laws that employers must abide by do not apply to their contracted workers.
Self-employment earnings are subject to taxation if a contractor’s net earnings equal $400 or more in a year. These taxes are reported to the IRS on either Form 1040 (U.S. Individual Income Tax Return) or Schedule C Form 1040 (Profit or Loss From Business).
In 2020, the self-employment tax rate for most independent contractors is 15.3% (12.4% for social security and 2.9% for Medicare).
Independent contractor taxes are handled differently than employee taxes. Employers do not withhold state and federal taxes for contractors. Instead, independent contractors pay the Self-Employment Contributions Act (SECA) tax on what they earn.
This tax is usually estimated and paid quarterly to the IRS via Form 1040-ES. The IRS provides a Tax Withholding Estimator tool to give independent contractors an estimation of taxes they will need to pay.
Estimated quarterly payments are required to be made by independent contractors who expect to owe more than $1,000 in taxes for the year.
An independent contractor 1099-MISC is the IRS form that an organization must have each contractor fill out after an independent contractor agreement is signed.