Imagine working for yourself doing what you love at your pace and not answering to anyone else. It sounds like the American dream, right? Well, that’s called being a contract worker. Almost 7% of workers in America right now are self-employed as independent contractors. This essentially means that they work for themselves instead of a corporation. It can start small with a couple of clients then grow into an entire business. Contract labor can be a confusing topic, but we’re here to make the subject more transparent.
There are a lot of unique rules and laws associated with being a contract worker. First, there are specific laws to help determine whether you are an independent contractor or employee. There are also certain rules employers must follow depending on how you are labeled. There are also huge differences in the way that you pay taxes. Here is a guide over everything you need to know about the rules and laws regarding being a contract worker.
What is an Independent Contractor?
It’s important to clarify the difference between a contract worker and an employee. An employee must work when the company schedules them, they are on the regular payroll, they get benefits from the employer, and they generally work on-site for one employer. An employee will sign a W-2 tax form when hired.
On the other hand, independent contractors work when they want, they get paid by the job, they don’t receive benefits, and they can usually work from home for multiple clients. An independent contractor will sign a 1099 tax form when contracted to do a job.
Some common examples of independent contractor jobs include:
- Barber/ hairdresser
- real estate agent
- security guard
- taxi driver
It’s important to remember that these are just examples. There are plenty of other professions where someone might be an independent contractor. There are also situations where people in the above-mentioned professions could be employees.
There are times when your employment status may not be especially clear. You might initially sign a contract but end up an actual employee after multiple extensions of the contract and being assigned more and more work. According to the IRS, you may be a full-time employee if you work more than 130 hours a month. This can get trickier if you are not paid by the hour.
If you believe that your employment status is mislabeled, be sure to talk to your employer to get it corrected. If you don’t, you won’t get the benefits of being an actual employee. If you meet the criteria of a full-time employee but your employer refused to acknowledge you as an employee, talk to an employment lawyer today to look into your options.
Benefits of Hiring an Independent Contractor
There are a number of reasons companies opt to hire independent contractors instead of a standard employee:
Independent contractors are 20 – 30% less expensive than a regular employee. This is because the employer isn’t responsible for health insurance or other costs, such as training. Training requires a lot of time. Plus, the company has to pay the trainer. A contract worker generally comes already trained in their skill.
Perfect for Temporary Jobs
Sometimes an employer has a job that needs to be done without the need for a permanent hire. Hiring a contract worker provides flexibility and lower payroll costs. After the job is done, both parties can part ways until there is more work.
Hiring an employee requires a lot more verification than an employee. It varies based on the company, but in many situations, you won’t need to do as much work to get a contract worker started compared to an employee.
When tax season comes around, it’s significantly easier for a company to handle a contract worker than a standard employee since the company doesn’t have to pay FICA taxes on those employees.
Disadvantages of Hiring an Independent Contractor
While there are plenty of advantages to hiring a contract worker, there are some disadvantages, too.
Finding Good Freelancers
As every employer knows, it’s important to hire the right person for the job. If you don’t, it could end up costing the organization money. When you hire an employee, you establish a relationship with them. You might not establish the same relationship with a contract worker. The next time you need them, they might not be available. That means that you may have to find another person. This requires you to take time to find the employee instead of doing other things you need to be doing. There’s also the chance that the employee won’t fit for the position. Unfortunately, you might find that out a little too late.
Potentially Lose Copyright
When an employee for a company creates something, it’s understood that the creation is the property of the company. When an independent contractor creates it, the contract could state that they own the copyright. That limits the profit you can make on the creation you hired someone to make. It may also limit the capacity in which you can use the product.
Risk of an IRS Audit
If you have a large number of employees labeled as independent contractors, the government might think that they are mislabeled since the company doesn’t have to pay taxes for independent contractors. If they think that employees are being mislabeled, they will likely run an audit. An audit is, at the very least, a huge headache for the company. It will likely be an expensive headache. If anything serious was going on, it can have devastating results. Most companies want to avoid an audit at all costs, so they may limit the number of contract workers they have on the team.
Possibility of Getting Sued
A contract worker is not covered by worker’s compensation. That means that if they get injured on site, they may be forced to sue the company to get compensation. Not being covered means that your company would have to pay the entire settlement. in some situations, this could ruin the entire company.
When To Hire An Independent Contractor
Now that we’ve gone over what the advantages and disadvantages of hiring a contract worker are, it’s time to go over when you should hire an independent contractor. The first and most obvious time to hire a contract worker is when you only need a single job done. If you only need a logo design for your company, you don’t need to keep the person on your payroll after the logo is done. Similar to construction jobs. Once the job is done, there’s no additional reason to keep them employed.
Another time you want to hire a contract worker is when the work doesn’t necessarily relate to your actual business. This could be something like hiring a maid service to clean your office. You could put someone on the payroll, but you can also hire someone on a contract basis.
Finally, you may want to try an employee out before you hire them full-time. Hiring the potential employee on a contract basis gives you the opportunity to see how they will approach the job. From there, you can determine if you’d like to move forward or not. This helps prolong the extra work and cost of a full-time employee until you are absolutely sure.
Benefits of Being an Independent Contractor
Employers aren’t the only ones who benefit from being an independent contractor. There are a number of reasons that a person would choose to be a contract worker.
Stay at home
Most contract jobs stay at home jobs. For most of us, it’s not a big deal to go to work in the morning. Many people don’t have this luxury. Many of us don’t even realize this is a luxury. However, some people aren’t physically able to get up and go to work in the morning as easily as others. If someone has a physical disability, they might prefer to work from home. They may feel safer and have the accommodations that they need.
Additionally, new mothers may enjoy the option to stay at home to care for their young children while still making a living. Unfortunately, a lot of mothers have to go back to work right away after giving birth to afford the things they need for their new baby. As an independent contractor, you can stay at home and work while your children color and play. Why pay for daycare if you don’t have to? It’s expensive, and you have to be away from your child.
Pick How Much You Work
Even if you have a contract job that requires you to go on site, being an independent contractor gives you the opportunity to choose exactly how much you work. If you have a health or family obligations, you can work more. When you have the availability to work more, you can do so.
Do What You Love To Do
As an independent contractor, you have the freedom to do the work you love. Instead of spending your days doing menial tasks for someone else, you can build your own company and choose the work you want to do. The more your business grows, the more freedom you will see. At first, you may not have the selection of work you’d like. As you get better at your craft and build your portfolio, the more options you will get.
Disadvantages of Being an Independent Contractor
The benefits of being a contract worker are sometimes priceless, but there are plenty of disadvantages, too.
Constantly Looking For Work
As an independent contractor, you have to go out there and look for work. That means reaching out to clients and applying for jobs more than actually working sometimes. Building your business can be slow going at first, but the more work you do, the more experience you have under your belt. This experience will allow you to get better jobs.
Responsible For Benefits
Most full-time employees get health insurance, paid time off, and a 401K. As an independent contractor, you will not get these benefits. You will be responsible for your own insurance, retirement plan, and you don’t get paid time off. Paying for health insurance can be especially expensive, so be sure to include that extra expense into your budget.
Responsible For Taxes
Just because an employer isn’t taking money out of your pay for taxes anymore doesn’t mean you won’t have to pay up when tax season comes around. It’s a good idea to save 10 – 20% of your pay so that you’re prepared when you see what you owe.
Inconsistent Work Load
As a contract worker, there may be times where it seems you have too many jobs. At other times, you will not have enough. This can make budgeting quite difficult compared to a standard job where you know exactly how much you will make every check. You have to have enough foreshadowing to plan financially for when the workload isn’t as large as other times. It takes a special personality type to handle this certain level of uncertainty.
Must Be Self-motivated
As a contract worker, it’s up to you how much you work. While this can be a good thing, it could also be a negative thing. This is only good for people who have a strong work ethic and have the ability to motivate themselves.
Employment Not Protected
Independent contractors do not have the protection that standard employees enjoy. For example, an independent contractor cannot sue an employer for wrongful termination. They also won’t get any compensation if they go on leave for a medical condition. Finally, they don’t get health care, social security, or worker’s compensation.
Things to Consider with Contract Work Contracts
Every independent contractor should sign a contract before starting work on a project to ensure that they will get paid. There are a lot of things to consider before you sign a contract to ensure that both the contract worker and employer are on the same page (and not being taken advantage of).
Every contract should have clear expectations of the job and what is expected during the assignment. As an employer, it’s important to be as detailed as possible in regards to what you want. It’s a good idea to highlight the most important aspect of the agreement to make sure that the contractor is aware of it. As a contractor, you need to read the agreement thoroughly and make sure that you agree to the terms of the agreement as well as the price.
If you are contracted to create something for a client, you need to be very clear about who owns the rights to the creation. Whoever owns the rights can do what they want with the product to make money. In some cases, you may be forced to give the client all of the rights. In this case, you will only get a flat fee for the product.
Many times, a contract will include a clause that a contractor must solely work on one project until it is done. This could limit the amount of work a contractor can get. If this is a part of the contract, as a contractor, you need to make sure that you will be paid throughout the duration of the job to be able to support yourself.
Deadlines are extremely important in a contract. If you don’t meet a deadline, you could void the contract and any work you completed would be worthless. Be sure that all deadlines are clear and attainable. If you work in a field, like construction, that may require alterations of any deadlines, be sure to include that in the contract or don’t include a date at all. Being honest about what the employer should expect from your work will result in a much happier client.
Unfortunately, there are times where an independent contractor can get scammed by an employer. It’s best to know what to look for to prevent this from happening to you. Here are some tips to avoid fraud:
- Research the company you will be working for
Always do due diligence before starting a job. Verify that the employer is legitimate. To do this, look them up on a site like glassdoor.com or visit someone in person. You can also ask for references from people who have worked for them in the past.
- Keep it local
If you work online, it’s best to keep all clients relatively local. Regulations in the United States may not apply in other countries. Fewer regulations can make it easier for a client from another country to void you when it’s time to pay.
- Get employee benefits if you deserve them
Too often, employers will hire an employee under the label of “independent contractor” to avoid having to pay the taxes and benefits associated with a full-time employee. To ensure this isn’t happening to you, ask yourself a couple of questions:
– Are you able to work when you want?
– Do you work for multiple clients?
– Are you able to work from home?
– Can you be safe from being fired?
– Are you already trained before taking on the job?
If the answer to these questions is yes, then you are probably rightfully classified as a contract worker. If you answer no one or more of these questions, you might not be misclassified. Possibly on purpose.
Taxes and Independent Contractors
One of the biggest differences when it comes to employees and contract workers involves taxes. Every person who generates an income has to pay taxes for social security and Medicare. For standard employees, these are called FICA taxes. For people who make under $128,400, this adds up to 15.3% of your salary. Employers generally cover half of the cost for their employees. Contract workers must pay the entire amount themselves. Since independent contractors don’t have taxes taken out of their income, they must pay it differently. Here is what you need to know as a client and as a contract worker.
As a Client
When an employer hires an independent contractor, they have the contractor fill out a 1099 tax form. The employer is responsible for filling it out correctly. The employer does not take out any taxes from the pay. This also means that they don’t have to pay any FICA taxes. This makes doing taxes much easier for the employer. The employer does still send the employee an earnings report at the end of the year to help the contractor have records of their earnings as long as they made more than $600. If the contractor does not fill out the tax form correctly, the company who contracted the job must keep backup withholding to cover the taxes just in case.
If for some reason the employee in question was wrongly labeled as an independent contractor as opposed to an employee, the employer must make the appropriate changes and pay taxes on the employee. However, the employer is protected by the safe harbor exception. This means that they won’t be required to pay the employee’s past FICA taxes while they were labeled an independent contractor.
As a Contract Worker
Every independent contractor who makes more than $400 must file self-employment taxes unless they are the owner of a corporation. In order to turn your freelance situation into a corporation, you must register with the IRS as either an LLC or S corp.
Those who make more than $3000 in a year must pay their taxes in four quarterly payments based on an estimate of what the contractor will earn.
All independent contractors must take the time to carefully record their earnings, especially if they are coming from a large number of sources. Stay organized. Keep receipts of payments and things you buy for your business so that you can deduct the costs from your taxes. Deductions that may apply to an independent contractor include:
- depreciation of work equipment
- health insurance premiums
- office supplies
- retirement fund contributions
Deductions vary based on the type of work. Since taxes can get complicated for independent contractors, it’s a good idea to go to a tax professional to ensure that you get all of the deductions you qualify for. You don’t want to end up paying more than you have to.
Everyone has to work. If you want to work on your terms, working as an independent contractor might be the best option for you. When you understand what to expect, you can organize your life appropriately and still enjoy the freedom that being a contract worker offers you. The next step is to find clients.