Is the thought of being self-employed attractive to you? You aren’t alone. Many people in a 9 to 5 job are leaving it so that they can pursue their own careers outside of the traditional work environment. If you decide to do this, you need to understand whether or not you are an independent contractor.
Simply put, independent contractors are always self-employed, but not all self-employed individuals are independent contractors. Here’s how you know the difference.
What Is an Independent Contractor?
Understanding what an independent contractor is is important when it comes to how you get paid and how you pay your taxes. The Internal Revenue Service (IRS) has a definition of an independent contractor. The IRS definition is “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.”
Let’s explore that definition. The payer is the person who hires you to do a job. According to the definition, the payer can only tell you what the end result should be. The independent contractor chooses the means by which they do the job. The payer does not dictate a daily schedule in the relationship but merely looks for the end service to be complete.
Independent contractors are service providers to the general public. They do not operate within an employer-employee relationship.
Examples of an independent contractors include:
- Private practice doctors
- Web designers
What Is a Self-Employed Person?
As the name implies, the self-employed person is an individual who works for himself. As you can tell by the definition of an independent contractor, you can see that the independent contractor fits the definition of a self-employed person. But not every self-employed person is an independent contractor.
Independent contractors sell services. Some self-employed individuals don’t sell services and instead sell goods. You refer to these people as a merchant and not as an independent contractor. Both are self-employed; the difference is what each provides to others.
Self-employed people usually have multiple clients in which they perform the same or similar types of work.
How Do Self-Employed Individuals Get Paid?
A self-employed individual is responsible for collecting payment and must pay taxes on what they earn. When they sell their goods or services, the other party is not withholding taxes which means that the self-employed individual is responsible for all reporting and payments.
Clients pay independent contractors a fee. At the end of the year, they will receive a 1099–MISC form from their clients that indicate the total amount paid to them for the contract. Don’t expect a W2 as an independent contractor. Independent contractors use the 1099 to file tax returns and pay the required state and federal taxes on the income received.
Merchants, on the other hand, must rely on bookkeeping to note how much revenue they earned for the sale of products. Merchants do not receive a 1099 at the end of the year.
Does an Independent Contractor Need a Business Entity?
Independent contractors can operate under their own Social Security number or file for a business entity with the state in which they operate. Filing for a business entity is a choice an independent contractor makes. It isn’t necessary.
You may opt to file for a limited liability company (LLC) or a corporation if you want to appear more professional and want to limit the liability that your business poses to your personal assets. When you are a sole proprietor with no business entity, your personal assets are subject to lawsuits and claims. By forming an LLC or corporation, you reduce the liability, limiting it to only business assets.
When you have a business entity, you want to make sure to keep bank accounts separate and not comingle business assets with personal assets to ensure you get the most out of the liability protection.
Filing Taxes as a Self-Employed Person
A self-employed person is responsible for paying all their own state and federal taxes. How you pay your taxes will depend on whether or not you formed a separate business entity. As a sole proprietor, you will file a standard tax return, the Form 1090. On this tax return, you will include a Schedule C that states your income as well as lists your deductions. Deductions allow you to reduce your income because you pay for certain materials or services that you need to run your business.
If you are a corporation, you will file Form 1120. This form goes through the income and expenses your company has. Filing the correct forms is important to remain compliant with IRS regulations.
Do Independent Contractors Need a Business License?
Independent contractors don’t need a license unless the type of work that they do requires a license by state laws. It is the type of work you do, not the status of independent contractor, that may require a business license. In other words, it doesn’t matter if you’re an employee or independent contractor, if the service requires a license, you must have one.
Examples of services that require licensing in most states include:
- Insurance agents
These professions require a license regardless of whether or not the person works for a company or for themselves. Check with your state commerce department to see if you need to get a license for your occupation or job.
The Insurance Needs of the Self Employed
When you are self-employed, you are responsible for the liabilities of your business activities. This means that someone can sue you or someone can hold you responsible for a loss such as a slip and fall accident where someone gets hurt. The liability exists regardless of whether you are a sole proprietor or a business entity. All the business entity does is it puts the lawsuits directly on the business assets and protects your personal assets.
Because there is a liability in either scenario, experts highly recommend insurance. Some scenarios may even require you to get insurance. For example, the state DMV requires commercial auto insurance for your business vehicle. Those awarding contracts may also require general liability insurance as one term for the gig.
Some common policies that a self-employed person might need include:
- General liability: Protects against third-party claims of bodily injury or property damage
- Commercial property: Pays to repair or replace business property lost due to theft, fire, or other covered peril.
- Worker’s compensation: Required in most states if you have one or more employees. Pays lost wages and medical expenses if an employee hurts himself while working.
- Commercial auto: Pays liability to a party that you hit while driving for work and can pay to repair your own vehicle after an at-fault accident if you choose the right coverages.
- Professional liability: Pays claims that state you did not do your job according to professional standards that resulted in injury or property damage.
Talk to an insurance agent to better understand what your liabilities are and how you can best protect yourself. You may need one or more policies to do the job.