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.

  1. Self-Employed

    A situation in which an individual works for himself or herself ...
  2. Subcontracting

    Subcontracting is the practice of assigning part of the obligations ...
  3. Household Employee

    An individual who is paid to provide a service within a residence. ...
  4. Day rate (oil drilling)

    In oil production, a day rate is the amount a drilling contractor ...
  5. Contractor Fraud

    Illegal business practices committed by firms hired to reform, ...
  6. Wrap-Up Insurance

    Wrap-up insurance is an all-encompassing liability insurance ...
Related Articles
  1. Small Business

    Should You Hire Contractors or Employees for Your Small Business?

    Learn the pros and cons of hiring independent contractors instead of regular full-time employees. Find out about a potential risk for severe tax penalties.
  2. Investing

    Tips For Dealing With A Renovations Contractor

    It pays to take the time and choose the right contractor for your next big home renovation project.
  3. Investing

    Top 6 Home Renovation Scams To Avoid

    Renovations are stressful, but if you rush through important details you could fall prey to one of these scams.
  4. Small Business

    Should You Incorporate Your Business?

    Find out how becoming a corporation can protect and further your finances.
  5. Taxes

    Small Business Tax Obligations: Payroll Taxes

    Don't leave it up to your accountant - owners are ultimately responsible for fulfilling tax obligations.
  6. Personal Finance

    Top 10 Fastest Growing Industries in the United States

    Six of the 10 fastest-growing industries are directly related to new residential construction.
  7. Taxes

    Become an LLC and Save Taxes Under Trump (Maybe)

    If President Trump gets the tax reform bill he wants, LLCs may be able to reduce their taxes – but not in the way you might think.
  8. Small Business

    Employee Or Contractor? An On-Demand Economy Problem

    Several on-demand economy startups classify, or classified, their workers as contractors rather than employees. It is an unconventional approach to hiring and has been a hit with venture capitalists ...
  9. Taxes

    Have Household Help? Don't Get In Tax Trouble

    Hiring household workers can be a complicated process. Know what the government requires so you can prevent penalties and problems down the road.
  10. Retirement

    How Social Security works for the self-employed

    As both employee and employer, you have to pay more in Social Security, but there are deductions that can help lighten the tax burden. Find out how Social Security works for the self-employed. ...
Hot Definitions
  1. Liquidity

    Liquidity is the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's ...
  2. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve ...
  3. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  4. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  5. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center