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Jean   Murray

Self-Employed vs. Independent Contractor - What is the Difference?

By April 26, 2009

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Someone asked me the other day, "What is the difference between being self-employed and being an independent contractor?" Good question. Self-employment is the more general term for those who are in their own small businesses, while independent contractor is more specific to people who work for others but are not employees.

IRS Definitions
The IRS defines "self-employed" like this:

If you are in business for yourself, or carry on a trade or business as a sole proprietor or an independent contractor, you generally would consider yourself self-employed.
The IRS defines "independent contractor" by stating that the person for whom the services are performed (the employer) has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.
So a self-employed individual can work for someone else as an independent contractor or he/she can sell products or services to others.

To clarify, here are three examples
Sam is a freelance writer who works for several companies writing company newsletters and promotional materials. He is self-employed, and in relation to each of these companies he is an independent contractor. That means he receives a 1099-MISC every year from each employer. His total annual income, minus allowable deductions for legitimate business expenses, is subject to self-employment tax.
Kathy is a quilter who has developed a new way of making quilt blocks. She has several self-published books and videos that she sells online and at quilting shows. She is self-employed, but since she doesn't work for someone else, she is not an independent contractor. She keeps track of her income from sales and her expenses and she pays income tax and self-employment tax on her net income.
Akim has a software business. He sells his software online, and he also does contract work for his former employer. He is self-employed, and he is also an independent contractor. He will receive a 1099-MISC from his former employer and he will also have income from sales of his software. He combines his expenses from his contracting work and his selling. These examples are over-simplified, of course, but you get the idea.

Sole Proprietor/Schedule C
Unless they have set up as a more formal business entity, self-employed individuals are sole proprietors and complete a Schedule C for their individual 1040, paying income tax and self-employment tax on their net income from their self-employment.

Self-Employment Tax
The most important thing to remember about self-employment, whether you are an independent contractor and work for others or you are offering services or products for sale, is that you must pay self-employment taxes, for Social Security and Medicare. You must pay the entire amount of these taxes (15.2 percent of your annual net income from your self-employment.

If you are working for someone else as an independent contractor, consider taking the next step and setting up an independent contractor business.

April 27, 2009 at 10:39 am
(1) Liz G says:

Great article, and it is definitely important to pay the requisite self-employment taxes if you’re an independent contractor or consultant.

Along with incorporating, an alternative to consider is working via a Portable Employer of Record. This option maintains your freedom to operate as an independent and get all your business expense tax breaks, and at the same time, you get access to group medical plans, complimentary business insurance, and a tax-advantaged 401(k) that works even better than a SEP IRA.

It’s not for everyone — this option won’t work for your quilter example — but for consultants who bill clients for their knowledge services and subject matter expertise, it may be a much more profitable way to operate. Thanks again for clarifying these issues!

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