Working as an Independent Contractor: Frequently Asked Questions

Questions

• What is an independent contractor? Should I become an independent contractor?
• What employee benefits do I miss out on by becoming an independent contractor?
• Who decides whether I'm an employee or an independent contractor? What if a government agency determines that I am an employee?
• Do I need to use written agreements when I do contract work for clients?
• How much should I charge clients and how can I make sure they pay me?
• Do I have to pay taxes on my freelance income?
• What skills do I need to become a successful independent contractor?
• How can I motivate myself to be self-employed?

What's an independent contractor? Should I become an independent contractor?

An independent contractor runs their own business. Unlike an employee who works for one employer, independent contractors are self-employed and provide services to multiple clients or customers. Consultants, freelancers, contractors, and gig workers generally operate as independent contractors.

One of the differences between independent contractors and employees has to do with the tax forms they receive: A contractor gets a 1099 whereas an employee gets a W-2.

There can be many advantages to being self-employed as an independent contractor:

• You're your own boss.
• The gig economy (which is made up of temporary, contract, and freelance jobs) is growing, and you might find more opportunities as a freelancer than as an employee.
• If you're successful, you might make more money than you would as an employee.
• You can take increased business deductions on your taxes.
• You'll have intellectual property rights in and ownership over your work product (unless you sign those rights away).

Despite the advantages, however, being self-employed isn't always a bed of roses. Here are some of the major drawbacks:

• You're responsible for generating your own revenue and managing your business expenses.
• Your clients might not always pay you the money you're owed.
• You must pay self-employment taxes.
• You might be personally liable for business debts (although you can manage this risk by operating as a limited liability company (LLC) or corporation).
• You have no employer-provided benefits.
• You have no unemployment insurance benefits.
• You have no employer-provided workers' compensation.
• You have few labor law protections.

For more information, read about the pros and cons of being a consultant, freelancer, or contractor.

What employee benefits do I miss out on by becoming an independent contractor?

As an independent contractor, you're not entitled to any employee benefits unless you bargain for such benefits in a written contract between you and the client. (In other words, you can include your preferred benefits in the terms of your independent contractor agreement.)

Absent any written agreement with the client that provides otherwise, your independent contractor status will cause you to forego each of the following standard employee benefits:

• health insurance
• the automatic deduction of your Social Security and Medicare taxes by your employer
• workers' compensation insurance (although, if you're injured on the job as an independent contractor, you might be able to sue the client for damages)
• the right to a minimum wage, and
• the right overtime compensation.

As an independent contractor, you also generally can't sue a client for employment discrimination based on national origin, color, religion, or gender; however, you can still bring a suit for racial discrimination.

Contractors also can't sue for wrongful termination unless your agreement includes a minimum contract term or certain conditions to termination.

Who decides whether I'm an employee or an independent contractor? What if a government agency determines that I'm an employee?

Initially, it's up to you and each hiring firm (or client) you deal with to decide whether you should be classified as an independent contractor or an employee. But this decision is subject to review by various government agencies, including the IRS as well as state workers' compensation and unemployment compensation agencies.

The IRS, to name one agency, looks at a number of factors when determining whether someone is an employee or an independent contractor. The agency is more likely to classify you as an independent contractor if you:

• work independently, without extensive supervision from your clients
• determine how and when to do the work
• make your services available to multiple clients at one time or over time
• can earn a profit or lose money depending how successful the business is
• furnish the tools and materials needed to do the work
• are paid by the job
• pay your own business and traveling expenses, and
• have written or oral agreements with your clients designating you as an independent contractor.

Whether the IRS sees you as an independent contractor isn't always the end of the story. Most states have their own laws that set the requirements to be an independent contractor for state income tax and employment law purposes.

(For more information on the criteria used to determine whether you're an employee or an independent contractor, see our article on preserving your status as an independent contractor.)

If a government agency determines that you worked as a contractor but should've been classified as an employee, you'll suffer some consequences. For example, the hiring firm might decide not to use you anymore because it doesn't want to pay the additional expenses of treating you as an employee. Or the hiring firm might insist on reducing your compensation to make up for the extra employee expenses.

And reclassification as an employee could create additional tax burdens for you. You could lose some of the tax deductions you were entitled to as a contractor.

Do I need to use written agreements when I do contract work for clients?

You really should use written agreements for your contract work. Using a written service agreement or independent contractor agreement can help to avoid disputes. Both parties can have a clear understanding of the work by providing a documented description of the services you're supposed to perform, when you're to perform them, and how much you'll be paid.

An agreement can also help establish that you really are an independent contractor rather than your client's employee. An agreement by itself doesn't definitively prove that a worker qualifies as an independent contractor. But it'll help show the IRS and other agencies that both you and the hiring firm intended to create a client-independent contractor relationship, not an employer-employee relationship.

When writing an independent contractor agreement, make sure you include terms and conditions that are most advantageous to you. You have a great opportunity to create the business relationship you want. While you can expect some clients to request certain modifications to their particular agreement, you can always have the comfort of starting every negotiation with favorable contract terms.

For example, your agreement could include provisions related to:

• prepayments (deposits)
• a guaranteed term
• intellectual property rights in your work product, and
• specific conditions for termination.

It'd be up to the client to raise an objection and insist on having any of these terms removed.

How much should I charge clients and how can I make sure they pay me?

When you're just starting out as an independent contractor, it can be tough to figure out what to charge your clients. You'll want to come up with a figure that pays your expenses, adequately compensates you for your time, and allows you to earn a profit.

But, of course, you'll have to make sure not to charge more than the market will bear—if other freelancers perform the same work for a much lower fee, you probably won't drum up much business.

(For tips on coming up with the right price, read about how much you should charge for your services.)

Just as important as doing the work is making sure you get paid. You can improve your chances of payment by invoicing soon after doing the work or on whatever schedule you and the client agreed to.

It's important that you stay on top of your unpaid client invoices and that you send reminders to slow-paying clients. If the client still doesn't pay, you might need to resort to legal action or turn the account over to a collection agency.

(For tips on collecting what you're owed, read what to do if a client won't pay.)

Do I have to pay taxes on my freelance income?

Yes, you must pay income tax on any income (minus business expenses) that you generate as an independent contractor. You meet this obligation by making quarterly estimated payments.

Because you're self-employed, you must also pay a self-employment tax that covers Social Security and Medicare taxes.

Fortunately, contractors can take advantage of some great tax deductions—for instance, if it applies to you, the home office deduction can reduce your taxes by a portion of your rent or mortgage.

What skills do I need to become a successful independent contractor?

Independent contractors wear two hats. You need to have a certain level of expertise in the services you provide so you can get and keep clients. But you also need to know how to track expenses, file taxes, and bill clients. In other words, you'll need to act as both the employer and the employee.

Most individuals or companies hire independent contractors because they expect them to have a particular skill set. By hiring a contractor, clients save the time and money of having to train employees to do the same work that a contractor can do more immediately and proficiently. Clients will pay you more than their employees because you can readily and competently complete the task at hand, with little to no supervision.

In fact, the more training and supervision that a client gives you, the more that you start to look like an employee to government agencies. As a contractor, you should not only have the requisite skills, but also an established, efficient methodology for completing the job.

But you can't just go home after the job is done. You'll need to be ready to personally satisfy (or effectively delegate) a number of administrative responsibilities to keep your business running.

As an independent contractor, you'll need to:

• manage client records
• apply for and maintain your business registration and licenses
• create and negotiate independent contractor agreements
• calculate, collect, and pay Social Security, Medicare, and other government taxes, and
• complete and file all relevant tax documentation (some of which must be obtained from your clients).

You might also have to manage any health insurance or other benefits policies for you or your agents.

How can I motivate myself to be self-employed?

Being an independent contractor means that you eat what you kill. Unless you and your client have an agreement that guarantees a certain volume of business, you'll only generate income if you can motivate yourself to regularly attract new business clients.

Unlike an employee, who might have a salary or some other form of guaranteed compensation, contractors must depend on themselves and their contact network for their livelihood. So you'll need to dedicate the time and energy to find, complete, and document your work.

While getting clients is one thing, completing your projects is another. Clients will expect tasks to be fulfilled thoroughly and within the agreed-upon time frames. As a contractor, you must set realistic goals. You also need to generate enough goodwill with clients so that if you require an extension of time for a particular project, they'll graciously grant you a bit of leeway.

It's all about performing consistently and managing expectations. Once again, as your own boss, you're responsible for motivating yourself (and your team) to complete assignments competently and in a timely manner.