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What is an independent contractor?

Independent contractor is a term used to describe people who are in business for themselves. Independent contractors earn their livelihoods from their own independent businesses instead of depending upon an employer to earn a living. Good examples of other terms used to describe independent contractors include consultants, freelancers, the self-employed and even entrepreneurs and business owners. Independent Contractor Agreement

What does it mean to be self-employed?

You are your own boss. When you're self-employed, you are your own boss, with all the risks and rewards that entails. You decide whom to work for, when to work and how to work. Many self-employed people report that the increased freedom they enjoy is the greatest benefit of self-employment.

No federal or state tax is withheld. Another advantage of being self-employed is that no federal or state taxes are withheld from your commission checks as they must be for employees. Instead, independent contractors normally pay estimated taxes directly to the IRS four times a year. This means you can hold on to your hard-earned money longer without having to turn it over to the IRS. Moreover, if you're self-employed, it's up to you to decide how much estimated tax to pay, but there are penalties if you underpay. The lack of withholding and control over estimated tax payments can result in improved cash flow for the self-employed as compared with employees.

Increased business deductions. Finally, when you're in business for yourself, you can take many tax deductions that are limited or not available at all for employees. As a self-employed person, you can deduct from your income tax any necessary expenses related to your business, provided that they are reasonable in amount and ordinarily incurred by businesses of your type. This includes, for example: office rent and other expenses, including those for home offices, travel expenses, entertainment and meal expenses (subject to limitations), equipment and insurance costs and more. In contrast, an employee's work-related deductions are severely limited.

You must pay self-employment taxes. Unlike employees who have half of their Social Security and Medicare taxes paid by their employers, self-employed people must pay their own Social Security and Medicare taxes. These are called self-employment taxes. The self-employment tax rate is 12.4% of an independent contractor's earnings up to the taxable limit for Social Security, and a 2.9% Medicare tax on all independent contractor's income.

No employer-provided benefits. You must pay for your own health insurance, often at much higher rates than those that employers pay. Time lost due to vacations and illness comes directly out of your bottom line. And you must fund your own retirement. The self-employed also don't have the safety net provided by unemployment insurance. There is no employer-provided workers' compensation.

You may be personally liable for business debts. Finally, if you're a sole proprietor or partner in a partnership, you are personally liable for your business debts. An Independent Contractor whose business fails could lose everything he or she owns.

 

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