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What is an independent contractor? A simple guide

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Medieval armies were often comprised of soldiers who sold their services to the highest bidder. These mercenaries were not citizens of the country or kingdom they fought for, but were instead hired to fight.

During the Middle Ages, these hired lancers were referred to by a number of terms based in Latin.

In 1819, the historical novel “Ivanhoe,” by Sir Walter Scott, contained the first recorded use of the English term “freelance.” Scott used the word to refer to the paid army of a feudal lord fighting in 12th-century England. Essentially, these soldiers, who did not belong to a specific country or kingdom, were free to fight — with a lance — for whichever army offered the highest compensation.

Scott’s term subsequently became part of the English language to refer to a person who does work on their own terms and without any permanent or long-term commitment to an employer.

Independent contractor definition

While the term “freelance” is still widely used in today’s workforce, companies and workers have also adopted the phrase “independent contractor” to designate workers who are not traditional employees.

An independent contractor is a self-employed worker who usually works under some type of contract or agreement. Independent contractors are contracted to perform work for — or provide services to — another entity as a nonemployee.

Independent contractor taxes

The IRS defines an independent contractor as an individual in a working relationship in which “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.” The IRS further clarifies this definition by stating, “You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done).”

It’s an important distinction for the IRS to make because employees and independent contractors are taxed differently.

Contractors typically do not have taxes deducted from the payments they receive as employees do from their paychecks. However, the IRS still requires income taxes, as well as Medicare and Social Security taxes.

The companies you work for are required to issue 1099 forms to detail how much you earned from them the previous year if earned more than a certain amount.

The earnings of a person who is working as an independent contractor are subject to the self-employment tax. The current self-employment tax rate is 15.3 percent; 12.4 percent for Social Security and 2.9 percent for Medicare. Contractors must also pay applicable state tax.

You do not necessarily owe taxes on the total revenue you collected in a year. As business owners, independent contractors are allowed to deduct their qualifying expenses, such as travel, advertising, and utilities.

To pay the self-employment tax, you may have to file Estimated Taxes quarterly with the IRS and your state’s taxing body. If you underpaid during the year, you may owe additional self-employment taxes when you file. If you overpaid, you may receive a refund.

Independent contractor jobs

Common types of independent contractors include:

  • Truck drivers often provide their services to freight companies. Yet they are typically not employees of those firms and can usually work for any company at any time.
  • Many creative professionals, such as writers, artists, and photographers, work on a project-by-project basis and are not employees of the companies they work for.
  • The drivers who work for rideshare services like Uber are usually independent contractors, not employees, of those companies.
  • Construction workers and tradespeople often work on projects independently and are not employees of the firm overseeing the projects.
  • Any consultant that provides services without receiving a fixed salary or benefits from an employer is an independent contractor. This includes professionals in the legal, financial, health care, and personal services industries.

Independent contractor vs. employee

There are pros and cons to being an employee or an independent contractor.

On the one hand, employees have a set salary they can count on as long as they remained employed. Independent contractors often have irregular income.

Independent contractors, however, have more flexibility and have unlimited earning potential compared with employees.

Employees have the advantage of qualifying for company health insurance, paid vacations, and other employer-sponsored benefits, while independent contractors have to pay for their own health, life, and disability insurance.

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Independent contractors also are not eligible for unemployment insurance or workers' compensation.

Learn More: Workers' Comp vs. Disability Insurance

Independent contractor agreement

Independent contractors operate more as a business partner than as an employee. The companies that employ contractors don’t have the same authority as they do over the work of their employees.

Therefore, in order to ensure the best possible working relationship, it’s important that there be an independent contractor agreement. There are a number of templates available online.

An independent contractor agreement should spell out:

  • The general terms of the working relationship. These include the parties involved, when and where the work will be performed and a description of the project and/or tasks to be performed.
  • Responsibilities and deliverables. The agreement should include a detailed description of what the contractor is expected to deliver.
  • Details of how and how much the contractor will be paid. The agreement should include the total amount to be paid for the project or the hourly rate to be charged by the contractor. The agreement should also include whether the payer will provide some of the total fee upfront or at different milestones.
  • Confidentiality agreement. It’s important that companies protect their intellectual property and company secrets. Therefore, a contractor agreement should include a section explaining that the contractor can’t disclose to a third party any of the information about the work being done.
  • The circumstances under which the contract will terminate. This could be an established date, the completion of the project, or a situation in which the contractor’s services are no longer needed.
  • Choice of law. Because independent contractors often work remotely, the agreement should specify which state’s laws will be used to enforce the agreement. Companies will typically use the state of their corporate headquarters.

Companies benefit from using independent contractors because they don’t have to pay benefits and unemployment insurance. They can also use contractors for short-term projects.

Independent contractors benefit from these arrangements by enjoying the freedom and flexibility of being self-employed.

Joel Palmer is a freelance writer and personal finance expert who focuses on the mortgage, insurance, financial services, and technology industries. He spent the first 10 years of his career as a business and financial reporter.

The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.

Published May 20, 2021