Definition of an Independent Contractor, How Taxes Work, and an Example

In this article, you will learn about Independent Contractor step by step. So without much to do, let’s get started.

What Is an Independent Contractor?

A self-employed individual or organization that has a contract to work for or offers services to another organization as a non-employee is known as an independent contractor. Independent contractors consequently have to cover their own Social Security and Medicare taxes.

An organization that hires an independent contractor is also exempt from the obligation to offer them employment benefits like health insurance and employer-sponsored retirement plans that the organization may otherwise offer to its workers. Each payee must be appropriately identified by the payer as either an employee or an independent contractor. An alternative designation for an independent contractor is “freelancer.”

KEY TAKEAWAYS

• Neither are independent contractors considered workers or entitled to employment benefits.
• They are required to pay anticipated income taxes in advance via quarterly installments rather than having taxes withheld from their paychecks.
• By using the permitted business deductions, Freelancers can lower their gross income and reduce their tax obligations.
• Independent contractors are responsible for making their own retirement and insurance plans.
• Independent contractors fall under a very broad spectrum.

Learning About Independent Contractors

The Internal Revenue Service (IRS) considers doctors, dentists, veterinarians, attorneys, and many other professionals who offer independent services to be independent contractors.1

Contractors, subcontractors, writers, software designers, auctioneers, actors, and numerous other individuals who offer independent services to the general public are also included in this category. The expansion of the so-called “gig economy” has resulted in an increase in the use of independent contractors.

Independent contractors are required to keep a record of their income, including each payment from clients. If the amount paid to the contractor justifies a 1099-MISC expense, clients are legally required to provide 1099-MISC forms to their contractors. A single-payer must provide an independent contractor with a 1099 form outlining their annual revenues if the contractor receives more than $600 from them.

Independent contractors need to weigh their need for freedom against the level of danger they are ready to take.

How To Pay Taxes as an Independent Contractor

Independent contractors are regarded as solo proprietors or single-member limited liability companies (LLCs) in the United States. If they have earnings or losses from rental properties, they must declare Schedule E instead of Schedule C on their Form 1040.34 Additionally, they are required to file Form 1040-ES, a self-employment tax return, with the IRS on a quarterly basis.

Independent contractors may not, however, be required to pay taxes on their gross income if they are sole owners. Their overall tax obligation may be decreased by allowable business expenses. The net income, which is subject to taxation, is the difference between gross income and business expenses.

Independent contractors must contribute 12.4% to Social Security on the first $147,000 ($160,200 in 2023) of net income and 2.9% to Medicare on all net income for the tax year 2022.6 If a single person’s self-employment income reaches $200,000 ($250,000 for married couples filing jointly), they must also pay an additional 0.9% Medicare tax.

Depending on the kind of product being made, certain independent contractors may also be required to pay state sales taxes.

Pros and Cons of Being an Independent Contractor

The benefits of working as an independent contractor typically have to do with their increased independence. They have the freedom to choose their working hours, the type of work they do, and the jobs they accept or reject. Those who are able to work from home could save money on clothing and travel expenses.

Additionally, they may be eligible for the home office tax deduction, which enables them to write off the business portion of their expenses for items like electricity, rent, maintenance, security systems, and insurance.

They have total authority over all aspects of business development, including client selection recruiting, and firing. There is no cap on how much money they can make, in contrast to employees who are paid a fixed annual pay. Finally, they will be able to feel proud of themselves for building a successful business that is solely theirs.

The risk of bankruptcy and the lost opportunity cost of a traditional profession are the drawbacks of working as an independent contractor. When business is bad, they don’t have a steady paycheck to fall back on, and their income fluctuates highly month after month and year after year.

Their ability to obtain mortgages, auto loans, and other loans is compromised by their fluctuating income. They lack the support and companionship of coworkers if they work alone, are liable for all business expenses, and are not eligible for reimbursement expenditure reports.

Independent contractors must pay the full cost of their healthcare because they are not eligible for employer-sponsored insurance coverage. The employer and employee portions of Social Security and Medicare taxes must also be paid by them. They are not qualified for 401(k) plans offered by their employers, nor are they eligible for matching funds from their employers.

Pros	Cons
Independent contractors are free to choose their own jobs and work schedules.	All of an independent contractor’s company expenses are their responsibility.
The amount of money they can make is not constrained by annual pay.	Their own healthcare must be paid for.
Working from home frequently allows them to save money.	They are not qualified for workers’ compensation or unemployment insurance.

Example of an Independent Contractor

An interior designer who works for themselves and has a clientele that hires them to decorate their homes is an example of an independent contractor. Even if they are employed by an architecture firm to work closely with their clients throughout the construction of a new home, the interior designer may be working on a contract for that company.

Although they have access to alternative retirement plans such as a SEP IRA, SIMPLE IRA, and solo 401(k), they are required to fund these on their own, and neither unemployment insurance nor workers' compensation benefits are available to them.

The designer, who is an independent contractor, would agree on project details with the architects (with whom they have a contract to work), but they might be in regular contact with the client during the decorating phase. As opposed to being an in-house designer who exclusively works for clients of the architecture business, the interior designer may be working on multiple residences and for other clients at the same time.

How Can You Become an Independent Contractor?

By working for oneself, you can become an independent contractor. In a gig economy, many freelancers become independent contractors who perform services or items on a contractual basis. Independent contractors are permitted to use a legally recognized business name, obtain any required certifications or permits, and submit estimated quarterly tax payments to the IRS.

What Is the Difference Between an Independent Contractor and Self-Employed?

A self-employed worker is the same as an independent contractor. In contrast to someone who knits hats and occasionally sells them at holiday fairs, who would be more like a freelancer, an independent contractor is someone who runs their own business, such as a dentist. They typically supply a good or service on a contractual basis.

Independent Contractors Explanation

How Do Independent Contractors Fill Out a W9?

It’s likely that if you are an independent contractor employed by a business or individual to provide a service, they will require you to complete a W-9 form. Information such as name, residence, and tax identification number must be verified. The IRS website offers access to every page of the W9 along with detailed instructions on how to fill it out.

How Do You Complete a 1099-MISC Form for an Independent Contractor?

Anyone needing it can access Form 1099-MISC on the IRS website. There are 18 boxes on the form that need to be filled out, and you also need to provide the recipient’s name, address, payee’s name, and both parties’ tax identification numbers. The IRS also offers detailed instructions on how to complete it.

How Is an Independent Contractor Paid?

You can pay an independent contractor by the hour, by the project, or by a flat fee, just like you would any other freelancer. Paying an independent contractor is possible through PayPal, Venmo, checks, or cash.

The conclusion

People who want flexibility, don’t mind irregular pay, and can manage their time well while potentially managing many clients may find success working as independent contractors.

Independent contractors must also feel at ease paying for their own insurance, filing their taxes on a quarterly basis with the IRS, and setting aside money for retirement. Some people find that the flexibility of working for themselves and the opportunity to select their own tasks are worth the challenges.

This is about Independent Contractor, and we hope you have learned something from this article and share your opinion about this article. What do you think about it, if you think this article will help some of your friends, do share it with them.

READ NEXT

Freelancer: Examples, Taxes, Benefits, and Drawbacks of Freelancer

What is Freelancing & What Does it Mean to Freelance?

How do I start freelancing?

What type of work can I do by freelancing?

Why are people freelancing?