The Internal Revenue Service states that independent contractors *are* self-employed. However, not all self-employed people count as independent contractors.
As it turns out, there are some important differences between these two, that can impact the way you do your work and pay taxes.
That’s just the topic of today’s article! Here we’ll explain to you how to confidently make a distinction between independent contractors and self-employed for legal purposes. To avoid confusion in your future ventures, you can get back to this article and check:
- What is an independent contractor
- What is self-employment
- The comparison between independent contractors and self-employed
- How to classify yourself
- Taxes, licenses, and insurance for independent contractors and self-employed
- What kind of business structures are available to independent contractors and self-employed
What is an Independent Contractor?
Let’s start with defining these terms, independent contractor first.
An Independent contractor is a person that provides the general public (companies or individuals) with goods or services.
Independent contractors, as their name suggests, have a great deal of independence in their work. US Supreme court/ Common Law rules propose a three-factor test to define who gets to be an employee, and who can be hired as an independent contractor:
- Behavioral control — Independent contractors are in charge through and through and have a great degree of control. Working hours, location, tools, equipment, and means of work, as well as the creative process in its entirety, are determined by an independent contractor. Additionally, they can pick each task as they please, according to the contract they’ve signed with the other side.
- Type of relationship — independent contractors are hired for a limited amount of time, to perform non-crucial tasks for other business entities. For example, a law firm may seek an SEO expert to improve their ranking, as a one-time thing.
- Financial control — independent contractors are in charge of the business aspect of their work as well. This means that they are the only ones to decide how they will invest their business income into the equipment and training, which should then bring them a competitive advantage over other independent contractors and freelancers on the market.
These are the basics of an independent contractor definition. To get the full idea, take a look at these articles on our blog:
- Independent Contractor Guide: Everything You and Your Clients Need to Know
- 7 Biggest Benefits of Being an Independent Contractor
What is Self-Employment and how it compares to Independent Contractors?
Just as independent contractors, self-employed people aren’t employees of any particular company. They do contract-based work for multiple clients; non-employees use freelancer websites, LinkedIn, browse job websites or rely on their reputation, recommendations, and word of mouth to find new clients, or be contacted by them. They can have direct contact with their potential clients and skip the HRs (unless they contact them first on behalf of the company looking for contract workers).
Both independent contractors and self-employed can freely choose what they’ll do, how and when they’ll do it, and for what rates. A skilled developer who writes in their spare time may offer content writing services as well, to earn an extra income and freshen up the working days.
This freedom comes with plenty of responsibilities, otherwise handled by company administration. All non-employees need to sort out their tax payments on their own, for each tax year they perform work that brings them more than $600. Income tax withholding by employers means that employees can rely on their company to handle payroll taxes. On the contrary, independent contractors and self-employed are individual taxpayers who hold tax liability themselves.
In addition to that, independent contractors and self-employed people miss out on significant employee benefits and protections.
US Labor Law only protects full-time employees, not independent contractors, freelancers, or self-employed. This means that they only have their compensation at their disposal and need to cover everything independently. There’s no paid time off, sick leave, pension, and 401k plans, or health insurance available.
Similarly, FLSA (Fair Labor Standards Act) standards don’t apply to non-employees, so there’s no minimum wage guaranteed to them, or unemployment/ workers’ compensation, for that matter.
Important info: CARES Act (Coronavirus Aid, Response, and Economic Security Act) passed by Congress entitles you to unemployment benefits. This applies if you’ve lost your job because of the pandemic, or if you/ a household member has contracted the virus.
Independent Contractor vs Self-Employed Worker: Learn how to classify yourself
There are many similarities between independent contractors and self-employed workers, so much that they may seem the same.
Now we come to the part that puzzles many freelancers who don’t have a full-time employee status — i.e, who work for themselves.
Independent contractors are self-employed, and there are very few exceptions to this rule. At the same time, not all self-employed workers may classify as independent contractors.
How come? Well, the best way to explain this is through an example of two scenarios.
Imagine you’re a fashion designer and work for multiple brands at the same time. Everything is contract-based and limited to certain clothing items, collections, or time-constricted. This is a typical independent contractor work, and you would count as self-employed.
In the other case, you’d work as a fashion designer, but strictly for yourself. Warehousing, workshop, orders, shipment, as well as designing and sewing clothes — all is done by you alone.
This goes in line with the independent contractor definition, with one main difference: you are your own boss but have no (other) clients at the same time. There are no contracts with other business entities like there would be in the previous case. You could hire other people to help you if there’s too much work, but keep in mind that this could qualify you as a small business owner.
Employer tip: Make sure to avoid misclassifying your employees as independent contractors! 20 Factor Test can also help determine the Independent Contractor legal status in the US and prevent employee misclassification