What Is an Independent Contractor and How to Become One

What Is an Independent Contractor and How to Become One

Discover what an independent contractor is, how to become one, and what tax requirements are involved.

Jemima Owen-Jones
Written by Jemima Owen-Jones
April 13, 2022
Contents
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Are you considering becoming an independent contractor? If so, we don’t blame you. According to the latest gig economy statistics, 78% of gig workers say they’re happier than traditional employees, and 68% say they’re healthier.

Why? Because gig workers typically have greater financial security, flexibility, and control over their work.

Below, we break down the definition of independent contractor, the benefits, and the process to become one. Whether you’re new to contracting or considering making the switch, this guide is for you.

What is an independent contractor?

An independent contractor is a self-employed individual or small business owner who provides services to client companies as non-employees, usually on a short-term or per-project basis.

Contractors have much more freedom and independence over their work than employees. The client cannot direct the contractor’s work beyond the project’s outcome and deadline. The contractor decides how, when, and where they complete a given project.

Unlike employees who receive a fixed salary or wage through a payroll system, contractors send companies invoices to receive payment. When paying employees, employers must withhold a percentage of the employee’s income for tax contributions. But clients do not withhold any income tax on the contractors' compensation. Contractors are responsible for withholding and paying their own taxes.

Finally, contractors do not receive the same mandatory benefits as employees, including those guaranteed by the Fair Labor Standards Act:

  • Minimum wage
  • Overtime pay
  • Retirement plans
  • Paid time off
  • Training
  • Expense reimbursement
 
Exception: Due to the pandemic, contractors are now entitled to unemployment benefits thanks to the CARES Act (Coronavirus Aid, Response, and Economic Security Act), which Congress passed in 2020.

Are independent contractors self-employed?

The Internal Revenue Service (IRS) states that independent contractors are self-employed. However, not all self-employed people count as independent contractors.

Self-employment is a general classification of how someone earns their income—being self-employed means not working for any particular company (other than your own one-person business, if applicable).

Independent contractors are a type of tax classification within self-employment. All independent contractors are self-employed, but not every self-employed person is an independent contractor.

Here are two scenarios that help to explain the differences:

Scenario 1: Imagine you’re a fashion designer and work for multiple brands at the same time. You sign contracts with different brands and design a limited collection of clothing items or work for them for a set period. This is typical independent contractor work (and you’d also count as self-employed).

Scenario 2: You work as a fashion designer, but strictly for yourself. You do it all on your own: warehousing, workshopping, designing, sewing, and shipping. The main difference with scenario 1 is that you are your own boss and sell directly to customers. You have no working-relationship contracts with other business entities. Your income is self-made, hence self-employed, but you would be better classified as a small business owner.

Independent contractor vs. employee

An employee is a worker that gets hired and managed by an employer and receives mandatory employee benefits. In contrast, a contractor is a worker who provides services to a company on a short-term or per-project basis and doesn’t receive employee benefits.

However, the business relationship employees and independent contractors have with their employer (or clients in the case of contractors) also differ in several other aspects:

Employees: Independent contractors:
  • Work for an employer
  • Work according to company-regulated schedule
  • Receive tools or reimbursements from the employer
  • Receive employer-provided onboarding and training
  • Share taxes with the employer and has taxes withheld from gross pay
  • Receive benefits like health insurance and retirement
  • Receive regular, fixed wages
  • Get direct supervision from a manager
  • Work with one or more companies as clients
  • Set their own schedule
  • Have their own tools and cover any business expenses
  • Come with skills and expertise and don’t need much/any training
  • Pay self-employment taxes
  • Don’t receive any employment benefits or FLSA protection
  • Receive hourly or project-based compensation
  • Receive minimal supervision and control their own process

You can also be an employee and an independent contractor at the same time, usually for different companies. For example, a full-time developer who loves writing in their spare time may offer content writing services to earn extra income.

Independent contractor vs. freelancer

Many use independent contractor and freelancer interchangeably, but independent contractor is a broader category that includes—but is not limited to—freelancer.

Independent contractor is a type of non-employee that pays self-employment taxes. They often work with multiple clients but may work with one single client. Freelancers are contractors who work with multiple clients, usually on short-term projects. All freelancers are contractors, but not all contractors are freelancers.

Are independent contractors sole proprietors?

No. Although both contractors and sole proprietors are self-employed individuals, they generate income differently.

A contractor is an individual hired to perform specific jobs for another business entity for a set rate. A sole proprietor, in comparison, is a single individual who owns and operates their own business, also known as a sole proprietorship.

Like contractors, sole proprietors may also perform contractual work for clients for a set fee. Still, they may have other revenue streams, like selling their products or services directly to customers.

Notably, a sole proprietor can also work as a contractor on the side, which means you can technically fall into both work classifications.

Popular independent contractor jobs

Popular independent contractor jobs include:

  • Photographer
  • Website designer
  • Virtual assistant
  • Bookkeeper
  • Delivery jobs
  • Landscaper
  • Digital writer
  • Editor
  • Blogger
  • Tutor
  • Online teacher
  • Transcriptionist
  • Life coach
  • Realtor
  • Graphic designer
  • Social media marketer

Should you become an independent contractor?

Becoming a contractor is a great option if you desire greater control, flexibility, and independence over your work. Contractors work with clients instead of employers, and they can choose when, where, and how they work, as long as they deliver on the client’s expectations.

Clients are typically willing to pay contractors higher rates than employees since companies don’t have to provide contractors with employee benefits or payroll taxes. Contractors need this extra money since they are responsible for withholding and paying their income and self-employment taxes and funding their healthcare and retirement accounts independently.

Contractors usually have to provide their own tools and equipment and, in some cases, carry liability insurance. Fortunately, contractors can often offset some of these business expenses by writing them off as deductibles. This lowers their taxable income and thus reduces their tax bill at the end of the year.

Advantages of independent contractor work

As an independent contractor, you can:

  • Tailor your workload and schedule to suit your lifestyle
  • Invest your money in a customized benefits program that suits your personal needs
  • Experience a greater variety of work
  • Meet new people
  • Broaden your experience and skillset

Drawbacks of independent contractor work

While there are considerable benefits to being a contractor, there are also potential drawbacks. As a contractor, you must:

  • Withhold your income and self-employment taxes from your earnings
  • Withhold health insurance payments and retirement contributions from your earnings
  • Source new clients to generate a steady source of income
  • Provide your own tools and equipment

How to become an independent contractor

People stumble into independent contract work in unique ways. However, being a contractor involves more specific requirements than many people realize.

For example, you must sign an independent contractor agreement for each project. And depending on where you live and the kind of work you do, you may also need to acquire a business license.

Choose and register your business name

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.

Once you’ve chosen a name, you can register as a business entity, enabling you to open a business bank account separate from your personal finances. This makes keeping track of your finances much easier.

As your business becomes more established, you may want to consider registering as a single-member limited liability company or SMLLC. Registering as an SMLLC means your business is a separate legal entity that provides you, the owner, with some protection and autonomy.

“Limited liability” means that if your business runs into any debts or legal disputes, you will not need to use your personal funds or property. Instead, you’ll only need to use the money and assets tied directly to the SMLLC to repay debts.

Obtain licenses for your vocation and location

Depending on your line of work and location, you may need to obtain a business license before providing services as a contractor. A business license is a government permit granted by your local government.

Most states do not require a business license to become an independent contractor within the US. However, some state laws, such as Washington’s, require all independent contractors to register business licenses.

Depending on your vocation, you may also need specific licensing to prove you are trained and certified in your field of work. Workers in the following vocations will likely require licenses:

  • Electricians
  • Childcare providers
  • Accountants
  • Real estate agents
  • Medical care providers
  • Stylists

Every contractor must obtain a tax registration certificate in their city even if their clients are not in the same location.

A tax registration certificate is a receipt that stipulates how much tax you need to pay to do business in your city. These documents are inexpensive, and you can quickly obtain one by registering with the local tax collector. In many cities, operating without a registration certificate is considered a misdemeanor.

5 tactics to find clients as an independent contractor

Growing a solid client base is essential for job security and avoiding gaps in your income when a project or contract ends. In an ideal world, you want to be turning down work because your schedule is too full.

1. Dedicate time out of your week to marketing your service and seeking new clients

The amount of time you devote to promoting your services and identifying new potential clients depends on the volume and type of work you want to do. However, a simple approach is to set aside a few hours per week to:

  • Obtain testimonials
  • Follow-up with referrals
  • Update a business website, or blog
  • Develop a prospecting list
  • Send out cold emails and pitches to prospective clients
  • Be active on social media

2. Create a profile on websites like Upwork and Fiverr

While we recommend all contractors eventually develop a polished and professional website, you shouldn’t let this hold you back from getting started.

While you’re still setting up as a contractor, take advantage of websites like Upwork and Fiverr. These platforms act as a marketplace to help contractors find projects, communicate with clients, and get paid.

While the pay might not be that high, and you will need to give a cut to the service provider, these platforms are still a good way for connecting with clients and building your portfolio.

3. Use competing freelancers as a ballpark for your pricing

Knowing your position in the market, your direct competitors, and your perceived value will help you price your services competitively without impacting your margins.

Contractors often set pricing for each client depending on the scope of the request. While prices may vary, it’s essential to have a base rate. A base rate ensures you earn enough money on each contract to cover your basic expenses and related business costs. When setting a base rate, account for:

  • Desired annual wage
  • Internet costs
  • Marketing costs
  • Office supplies
  • Rent
  • Utilities
  • Taxes
  • Any other administrative expenses

As you gain experience and build your portfolio, raise your base rate accordingly.

4. Carve out a niche to attract higher-paying clients

It’s a good idea to refine your service offerings gradually. The most successful businesses typically provide specific services.

Most contractors start their career as generalists because they haven’t yet discovered their niche, and that’s perfectly fine. However, as you gain more experience, you may see a pattern emerge or find that you lean toward a particular type of project or client. That’s working within a niche.

A niche helps establish credibility and sets you apart from your competitors. Clients are typically happy to pay a higher price for a service that speaks directly to their unique problem instead of a cheaper service that provides a somewhat applicable solution.

For instance, a freelance copywriter earns $29.59 per hour on average in the US. In comparison, a freelance medical copywriter makes $39 per hour on average in the US.

5. Build and leverage your network

Building a network of contractors in your field will provide you with a group of trusted industry peers to call on if you need any insights, inspiration, or assistance with a problem or query.

Contractors with strong networks also benefit from referrals to new roles and projects to help you generate a steady flow of work.

What is an independent contractor agreement?

An independent contractor agreement is a document outlining the business relationship between a hiring company and a contractor. These legally binding written documents establish clear expectations regarding the scope of work and rate of pay. This document can also protect both parties in the case of worker misclassification.

All contractors should ask their clients to create an independent contractor agreement for every project.

If your agreement describes a contractor relationship, but the client treats you like an employee, they have misclassified you. Misclassification means the employer should withhold your taxes and pay them on your behalf. You should also be entitled to employee benefits.

The IRS is on the lookout for companies misclassifying employees as contractors in the US. The IRS is aware that companies may hire “independent contractors” and then require that they function as full-time employees. Some companies do this to avoid paying payroll taxes and providing statutory benefits to contractors.

How to get paid as an independent contractor

Your rate and frequency of pay should be agreed upon by yourself and the client in your independent contractor agreement. Before you sign the agreement, decide if you want to charge the client by the hour or by project and how frequently you want them to pay you.

Use invoices to charge client companies

Contractors typically invoice their clients to receive payment. An invoice is a document that the contractor sends to the client via email. It should include the following information:

  • The title “Invoice”
  • The number of the invoice (1 if it’s the first invoice)
  • Your business or personal name and address
  • A clear description of the services you are invoicing for, with each service on a separate line
  • The date of supply
  • The date of the Invoice
  • The amount of the individual services to be paid
  • The sum total of all goods listed on the invoice
  • Payment terms, for example, payment within 30 days.
  • The preferred payment method (for example, your bank sort code and account number for BACS payments)

If you choose to work with international clients, numerous payment methods are available to avoid costly transfer fees. You can find a list of international payment methods here.

Access your money, when you need it

If you’re paid through Deel, you can receive your salary up to 30 days early, without insane interest rates, confusing T&C’s, or late repayment fees.

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How to pay independent contractor taxes

As we mentioned, independent contractors are responsible for their own taxes. Their client companies don’t offer tax withholding or employer contributions like they would for employees.

Understanding your tax obligations as a contractor can be daunting, especially if you’ve only worked as an employee before. Being self-employed requires getting familiar with different taxes since you must pay them yourself. As an independent contractor, you will need to pay both self-employment and income taxes.

Pay quarterly self-employment and income taxes on all compensation earned as an independent contractor

The self-employment tax is the contractor’s version of the FICA tax usually paid by employers. Self-employment tax consists of Social Security tax and Medicare taxes.

The self-employment tax rate is 15.3% of your net earnings as a contractor. The rate comprises two halves:

  1. Half of the tax (7.65%) is the “employee’s” portion
  2. The other half (7.65%) is the “employer’s” portion
As a self-employed person, you have to pay for both parts. But the IRS (internal revenue service) recognizes that’s not fair, so you can claim the employer’s portion (again, 7.65%) as a deduction when filing your tax return.

The second tax on your list is the federal income tax. The tax system is progressive in the US, which means you pay more when you earn more. There are seven tax brackets in 2021, ranging from 10% to 37%.
 

Claim deductions to reduce your income tax

You can reduce your income tax by claiming deductions from your business income. These deductions often considerably lower the amount of your taxable income. Therefore, knowing everything you can claim on your tax return will help you reduce your tax bill as much as possible.

We cover the following tax deductions in-depth in our tax deductions guide, but here’s a quick overview of some typical expenses you can claim:
  • Home office expenses
  • Health insurance
  • Car expenses
  • Advertising and promotion
  • Bank fees
  • Equipment depreciation
  • Cell phone and internet expenses
  • Education expenses
  • Travel expenses

Independent contractor tax forms

In this section, we go over the tax forms contractors must fill out throughout each tax year:

  • Form W-9
  • W-8BEN
  • 1099-NEC
  • Form 1040

Form W-9: Share your Social Security or tax identification number with your client

If the client intends to pay the contractor $600 or more in a year, they must provide the contractor with form W-9 to fill out and return before business commences.

The contractor must complete the W-9 form by entering their name, address, and Social Security number or tax identification number and return it to the client. The client will then retain this form for four years should any questions arise from the IRS.

The Form W-9 acts as an agreement that the contractor is responsible for withholding taxes from their income. The client also uses the information on the W-9 to complete a 1099-NEC form at the end of the tax year. We explain what the 1099-MISC form is later in this article.

From W-8BEN (or W-8BEN-E): verify your country of residence (non-US)

Contractors who lack US citizenship or residency but have worked in the US or earned income in the US must complete form W-8BEN before they receive their first payment from a US client.

A W-8BEN form is a tax document used to certify that your country of residence is outside of the United States for tax purposes.

If you’re a resident of a foreign country with whom the United States has an income tax treaty, submitting a Form W-8BEN may reduce your tax or exempt you from paying US tax altogether.

The contractor must download and complete Form W8-BEN by filling in their:

  • Full name
  • Street address
  • Country of residence
  • Tax number
  • Date of birth
  • Article number (US tax treaty information)
  • Withholding rate

Finally, the contractor should sign and date the form and return it to the client, where it will remain on file and valid for the remainder of the year and for three full calendar years after that.

Form 1099-NEC: Report your wages to the IRS

Form 1099-NEC is a way for clients to report the contractor’s income to the IRS.

If a contractor receives $600 or more from their client in a tax year, they can expect to receive a 1099-NEC form from their client.

The contractor must complete the form by providing the following information:

  • The clients’ information (name and address)
  • The contractor's information (Name, address, and taxpayer ID)
  • The total amount of compensation paid during the year
  • Any federal income tax withheld
  • Any state tax withheld
  • The total state income to the contractor for the year

The contractor must return this form to the client so they can file it with the IRS by January 31 each year.

If a contractor does not receive the 1099-NEC form by the end of January, they should request it from the client directly.

Form 1040: File a return for your self-employment income

The IRS Form 1040 is one of the official documents that US taxpayers use to calculate and file their taxable income by the April tax deadline.

Before contractors file a return for their self-employment income, they must first determine if they made a profit of over $400. Contractors only need to file a return for self-employment income if their net earnings (revenue minus expenses) from the business exceed $400.

If your net earnings are under $400, you still need to file an income tax return if you have other earnings, such as employment income.

Contractors can calculate their business’s net income or loss on Schedule C of Form 1040.

Regarding self-employment tax, you’ll use Schedule SE on Form 1040 to calculate how much you owe based on the self-employment income.

What if my client starts to treat me like an employee?

Sometimes, an independent contractor relationship drifts to become an employer-employee relationship. If you’re concerned, bring this up with your client sooner rather than later to spare them from misclassification (and receive employee rights and benefits). If your client does not budge, fill out Form SS-8 to get input from the IRS.

Long-term contractor arrangements are a common reason for blurred lines. Over time, contractors may find the client expects them to behave in ways associated with full-time employees, like working full-time hours or being told how to do their job.

The IRS and the Department of Labor are particularly interested in misclassification since it is considered a tax violation that can result in penalties for the client.

In the case of a wrongly classified independent contractor, the client should have been withholding tax contributions on the worker’s behalf. In addition, the client should provide the worker with mandatory employee benefits such as worker’s compensation, unemployment insurance, and healthcare coverage.

Before getting the IRS involved, you and your client have some materials to determine whether to convert to employment.

Review the IRS “Independent Contractor (Self-Employed) or Employee? Criteria

The IRS has devoted a page on its website to help workers and businesses understand worker classification.

The page displays three criteria areas that contractors can review to determine how much control and independence they have in their relationship with a client to determine if they are misclassified. This criterion includes:

  • Behavioral control
  • Financial control
  • Nature of the relationship

If, after reviewing this information, contractors are still unclear whether the client has misclassified them, they can file Form SS-8 with the IRS. The IRS will review the facts and circumstances and officially determine the worker’s status.

Be aware that it can take at least six months to receive a determination from the IRS.

Use Form 3949-A to report misclassification to the IRS

If the contractor believes the employer has misclassified them, they should complete Form 3949-A. Contractors use this form to report misclassification and subsequent tax violations to the IRS.

The form asks a series of questions about the nature of the work and how the client treats the contractor on the job. After the IRS receives the form, it will contact the client to get their version of the facts.

If the case is in the contractor’s favor, the IRS may award the contractor with a percentage of the amount of tax that the client underpaid.

Independent contractor FAQs

Why do independent contractors pay more taxes?

A contractor is effectively self-employed and uses their income to pay self-employment payroll taxes. Generally, when you are employed, your employer pays half of your employment taxes, and the employee pays the other half. If you are self-employed, you will pay both shares of the payroll tax.

So if you earn $100 as an employee, you will pay $7 in payroll taxes in addition to income taxes. If you make $100 as a contractor, you are self-employed and pay $14 in payroll taxes and income taxes.

However, contractors often receive higher pay than employees to offset these greater tax responsibilities.

How much can you make on a 1099 before you have to claim it?

You can make up to $600 before you need to confirm your earnings on form 1099-NEC. Your client(s) will provide you with this form and file it to the IRS on your behalf by January 31 each year.

Should I discuss potential misclassification with my client?

Yes. It’s perfectly reasonable to address the possibility of misclassification with your client. They may agree to review your classification and reclassify you as an employee.

Explain that you think the client has wrongly classified you as an independent contractor. At the very least, you should get an explanation as to why they believe you are a contractor instead of an employee.

What should workers do if their client keeps them under independent contractor status when they think they should be considered an employee?

Get the IRS Involved. If trying to talk to your employer doesn’t work, you can report the client to the IRS using Form SS-8. There is no fee for filing.

Use Deel to generate contracts, pay invoices and avoid misclassification

Are you starting out as a contractor? Or perhaps you’re a business owner looking to hire your first contractor. Either way, Deel is here to help.

Deel has many helpful resources on the benefits of being an independent contractor, contractor misclassification, and more on our blog. Alternatively, we can help businesses hire contractors internationally by generating compliant and legally vetted contractor agreements and pay a team of contractors worldwide using innovative payment methods with just one click.

Want to learn more? Book a free consultation to see how Deel can help make global hiring even easier for your team.

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