Working as an Independent Contractor: Frequently Asked Questions

Questions

• What is an independent contractor? Should I become 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 is 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 are your own boss.
• The gig economy (which is made up of temporary, contract, and freelance jobs) is growing, and you might find more opportunity 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.

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

• You are 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, see Being a Consultant, Freelancer, or Contractor: Pros and Cons.

Who decides whether I'm an employee or an independent contractor? What if a government agency determines that I am 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 and 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
• 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 statutes 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 Preserving Your Status as an Independent Contractor.)

If a government agency determines that you worked as a contractor but should have 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, if you 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 agreement avoids disputes 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.

A written independent contractor agreement can also help establish that you really are an independent contractor rather than your client's employee. Although an agreement by itself doesn't definitively prove that a worker qualifies as an independent contractor, it will 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.

For additional tips on proving that you're an independent contractor, see Preserving Your Status as an Independent Contractor. For information on what to include in a contract, see Use Written Service Contracts for Your Clients.

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 at 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, see How Much Should You Charge for Your Service?)

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 may need to resort to legal action or turn the account over to a collection agency.

For tips on collecting what you're owed, see 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 do meet this obligation by making quarterly estimated payments. (For more information on estimated taxes, see Paying Estimated Taxes.)

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. (For more information, see The Home Office Tax Deduction.)

For detailed information on working as an independent contractor, see Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants, by Stephen Fishman (Nolo).