DEFINITION of 'Independent Contractor'

An independent contractor is a self-employed taxpayer who controls his own employment circumstances, including when and how work is done. Independent contractors are not considered employees, and they must pay their own Social Security and Medicare taxes. It is up to the payer to correctly classify each payee as either an independent contractor or an employee.

BREAKING DOWN 'Independent Contractor'

Doctors, dentists, veterinarians, lawyers and a host of other professionals who own their own businesses are classified as independent contractors by the Internal Revenue Service (IRS). However, the category also includes contractors, subcontractors, freelance writers, auctioneers and others who provide independent services to the general public.

Employee Versus Independent Contractor

When a business owner or anyone else decides to pay someone for work, he must classify that individual as an employee or an independent contractor. To be classified as the latter, the worker must perform services not directly controlled by the employer. For example, the employer may order a certain end product, but he cannot control when the contractor does the work or the processes involved.

In contrast, when a business owner hires an employee, he has the liberty to control all of those elements including when and how the work is completed, but in return, he has a commitment to provide his employee with certain benefits, such as matching his Social Security and Medicare contributions. Independent contractors, in contrast, must cover their own expenses and pay their own taxes.

Filing Taxes

In the United States, independent contractors, also called self-employed individuals, are considered sole proprietors of their own businesses. They must report all their income and expenses on Schedule C of Form 1040, or Schedule E if they have profits or losses from rental properties, and they must submit self-employment taxes to the IRS. As of 2015, independent contractors pay 12.4% in Social Security contributions and 2.9% in Medicare payments on the first $118,500 of their earnings. They must also pay income taxes on their earnings.

However, as sole proprietors, independent contractors do not have to pay taxes on their gross earnings. They report their gross earnings but then subtract their business expenses from them. The difference is their net income, and the IRS taxes them on that amount. Employees, however, must report all of their earnings and pay tax on all of them.

Tracking Earnings

Independent contractors must track all of their earnings including every payment they receive from their clients. However, some clients may issue 1099 forms to their contractors. If an independent contractor earns more than $599 from a single payer, that payer is required to issue the contractor a 1099 form detailing his earnings for the year.

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