A reader question got me to thinking that I haven't been clear about the difference between a sole proprietor and an independent contractor. They are essentially the same: both are self-employed. And, just to make things muddier, a business owner can be both a sole proprietor and an independent contractor. The big difference is in how they are considered for certain taxes. Here's what I mean: the sole proprietor is a type of business for income tax purposes, and an independent contractor is the opposite of an employee, for payroll tax purposes. To clarify:
A sole proprietor is a one-person business that has not registered with a state as a business entity, such as a corporation, partnership, or LLC. in other words, a sole proprietor is the default business type, for income tax purposes, for a business. If you start a business, count business expenses and income separately from personal expenses and income, and you do nothing to register your business with your state, you're a sole proprietor.
What is an Independent Contractor?
An independent contractor is someone who is working for someone else, but who is not an employee; the independent contractor receives a 1099-MISC at the end of the year, instead of a W-2, showing total income received from companies for whom the contractor has worked. An independent contractor can be any type of business entity (sole proprietor, corporation, LLC, partnership), but most independent contractors are sole proprietors. Since the independent contractor is not an employee, no payroll taxes are deducted from payments to the contractor, so the contractor is responsible for paying self-employment taxes (Social Security and Medicare), along with income taxes.
How Can I Be Both a Sole Proprietor and an Independent Contractor?
You can see that these two designations really only are relevant to income taxes and self-employment taxes, so you can be both. There's nothing you need to do; it's just how you are viewed for different tax purposes.
All about Sole Proprietorships
Independent Contractor vs. Employee
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Thank you very much for this. It really helped me out, like a lot
so did some of your other articles.
Dream BIG,
Avery
Nicely stated straightforward very American explanation of our opportunities and requirements for these two work options.
thanks a bunch!
Thanks for this article! It’s very useful to me. But can I count business expenses and still be an independent contractor? I consider myself a sole-proprietor…but I generally only receive 1099’s…so I guess that makes me an independent contractor?
Yes, you can count business expenses and still be an independent contractor. You include those business taxes on your business tax return – Schedule C, which gets filed with your personal tax return. Your 1099 income is the income on the Schedule C.
For example, I receive a 1099-MISC from About.com for my work on this GuideSite, but I also receive other business income. It all goes on my Schedule C, along with the expenses for all parts of my business. I hope that helps clarify things.
Dear Jean,
My husband and I are starting a running group/club and I am wondering what would be the best for us. Should we become a LLC or just do it as a sole proprietor? We plan on charging a small fee to cover basic costs but we probably won’t make a profit on it and if then just a small one. Down the road we are also planning on hiring some coaches and I am wondering if that is possible as a sole proprietor? On a different note do you know if we need a liability insurance or if a waiver would be enough?
Thanks a lot for your help.
Deb
I was asked to get an EIN number for one person to pay me for a project, but I dont want to have to get a business license, and from what you said above I guess I don’t need one, is that right?
I won’t be using a DBA just my own name, and Im not offering a “service” or starting a store or anything, just showing up to work…. does this sound right, that I don’t need a business license? Im in Orange County, Calif… thanks for your input if you can respond to this!!
Thanks for the question. First, remember I’m not an attorney and I am not giving legal advice. If you are operating your business from home – working from home – you would definitely need a business license. If you are not working from home, but are working for a business on their premises, you may or may not need a business license; it depends on the city.
You may need a business license even if you are working at another location. The only way to find out is to call the appropriate department in your city to find out; ask ask a general question, like “If an independent contractor is working at another location – not from home – does that business need a business license?”