What is an Independent Contractor?

Robinhood Learn
Democratize finance for all. Our writers’ work has appeared in The Wall Street Journal, Forbes, the Chicago Tribune, Quartz, the San Francisco Chronicle, and more.
Definition:

An independent contractor is a worker, tradesperson, or professional who performs work for, or provides services to, a business or individual without becoming an employee, meaning they control more aspects of their work.

🤔 Understanding independent contractors

An independent contractor is a person who performs work or a service for an individual or company without becoming employed by that person or company. In a typical employment relationship, the employer can specify how, where, and when the employee performs work. For example, the employer could assign an employee to work from the office between 9 a.m. and 5 p.m. on weekdays. By contrast, independent contractors typically control most aspects of their work, such as where and when they perform the work. The company contracting their services only has a right to expect the result of the work as agreed upon. Independent contractors are considered self-employed.

Example

A freelance writer is an example of an independent contractor. A newspaper that needs an article written may find a freelancer and ask them to write a 500word article about a local fair, with a deadline of Friday afternoon. Unlike an employee of the paper, who may have to work in the office on a regular basis or may be assigned to visit the fair for two hours on Wednesday, the freelancer can investigate the story and write it on their own time, from wherever they’d like.

Takeaway

An independent contractor is like a mercenary…

When a movie villain hires a mercenary to take down the hero, the villain doesn’t go through a full hiring process, offer an insurance package, and tell the mercenary when and where to go to fight the hero. The villain simply pays the mercenary and lets them handle the specifics of hunting down the hero. Independent contracting is similar. The business working with the contractor simply tells them what needs doing and lets the contractor handle the specifics.

Ready to start investing?
Sign up for Robinhood and get your first stock on us.
Sign up for Robinhood
Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

Tell me more…

What is an independent contractor?

An independent contractor is a person who works with a company or individual without becoming an employee of that company. For example, a personal chef who cooks meals for different people each night is likely an independent contractor rather than an employee.

According to IRS rules, the thing that determines whether someone is an independent contractor is the level of control they have over their work. If the contractor has control of aspects of their work such as the time and location of the work, and how the work will be done, they are likely an independent contractor.

Companies hiring independent contractors cannot dictate these aspects of how the work gets done, but they can expect that the results of the work will be what they agreed on with the contractor and that the work will be completed by a certain deadline. By contrast, with an employee, a business can dictate hours when the employee must be present in the office or require that they work from a certain location.

Independent contractors are not employed by the individuals or companies with which they work. That means they aren’t eligible for many employer benefits, such as health insurance or 401(k) plans. Instead, they are self-employed, which makes them responsible for things like payroll taxes (Social Security tax and Medicare tax).

Sometimes, employers will incorrectly classify employees as independent contractors. This lets the employer avoid costs such as taxes, paid time off, health care, and 401(k) plans. This is illegal, and businesses that do this ultimately may have to pay the employment taxes that they should have been paying for the employee all along.

Who qualifies as an independent contractor?

According to the IRS, professionals like doctors and lawyers, contractors, and tradespeople who offer their services to the public are generally independent contractors. For example, if you hire a plumber to help fix an issue in your home, that plumber is usually working for you as an independent contractor.

To qualify as an independent contractor, a worker must meet the following requirements across these categories:

  • Behavior. Can the employer control how or where the work is performed? If so, the worker is an employee rather than a contractor. With an independent contractor, the employer can only control the output of the work.
  • Finance. Are financial parts of the work controlled by the employer? Independent contractors typically provide their own tools and invoice the employer for payment. If the employer provides tools and controls most of the financial aspects of the work, the worker is an employee.
  • Relationship. Independent contractors don’t receive benefits like paid time off, insurance, or retirement contributions. If an employer offers these benefits to the worker, the worker is an employee rather than a contractor.

Independent contractors can also work for individuals. They must meet the same requirements to qualify as a contractor whether they work for an individual or company.

What is the difference between an independent contractor and an employee?

The primary difference between an independent contractor and employee is that companies can exercise much more control over employees than they can over independent contractors.

Generally, a person or company gives an independent contractor a task to complete, such as fixing a leak in some plumbing or writing an article about a specific topic. The contractor is then free to accomplish the task in their own way, using their own tools, at their own pace. There may be a deadline involved, but the contractor isn’t under any requirement to work on the task for a set number of hours a day from a certain location.

Employees generally receive more detailed instructions about the things they have to do, such as where they must perform the task, how they must do it, and the time they have to dedicate to it. Employees often receive training to help them accomplish tasks while independent contractors typically don’t receive similar training.

Payment is another important differentiator. Employees typically receive set, guaranteed pay based on time worked, regardless of how much work they accomplish. The employer also doesn’t have to pay payroll taxes when paying independent contractors, though the contractors must pay self-employment taxes.

Independent contractors frequently get paid based on the completion of work. For example, a company might contract a graphic designer to redesign its website and pay them $500 for the finished piece, regardless of whether it took 10 hours or two hours to make.

Independent contractors also tend to have less permanent roles with a company. If the contract implies that the work will last indefinitely, that can indicate an employer/employee relationship. If there is a set end date, that can indicate a contracting relationship.

What is the difference between an independent contractor and a subcontractor?

A subcontractor is a contractor hired by another contractor to help that independent contractor accomplish a task.

Businesses or individuals work with contractors to have those contractors accomplish a task. The contractor then contracts other people, subcontractors, to help them perform that task.

For example, if you need to renovate your home, you might work with a general contractor that specializes in home remodeling. The contractor then subcontracts a plumber, electrician, and interior decorator.

What is included in an independent contractor agreement?

When a company works with an independent contractor, the two parties usually sign an independent contractor agreement, outlining the terms of the work.

Typical inclusions are:

  • A description of the work to be done
  • How long the contract lasts
  • The terms of payment
  • The rights and responsibilities of each party
  • A clause outlining the process for ending the agreement
  • A section outlining non-disclosure agreements and disclaimers

How is income paid and reported for an independent contractor?

The IRS considers Independent contractors self-employed, so the people hiring contractors do not need to withhold taxes on their behalf. Instead, the contractor is responsible for withholding and paying their own taxes.

Often, for the independent contractor, this involves paying quarterly estimated taxes to the IRS to ensure that the contractor pays most of their self-employment tax liability throughout the year.

Companies that work with independent contractors must submit Form 1099-NEC to the IRS and the contractor. This helps the contractor and the IRS track the income the contractor earned.

How do independent contractors pay taxes?

Independent contractors pay taxes just like anyone else. They have to pay income tax based on their taxable income.

One major exception is self-employment tax, which funds Medicare and Social Security. Self employment taxes total to 15.3% of all income earned.

Typically, employers pay half of their employees’ Federal Insurance Contributions Act (FICA) taxes, covering contributions to these programs. But because independent contractors are self-employed, they are responsible for both the employer and the employee portion of FICA taxes.

Unlike employees, independent contractors generally pay quarterly estimated taxes. These tax payments require the contractor to pay most of their tax liability over the course of the year rather than in a lump sum during tax season. Filing quarterly taxes is important for contractors because the IRS may impose penalties on people who owe too much when they file their tax returns.

Which laws and regulations affect independent contractors?

There are many regulations that affect contractors, including the determination of whether someone is a contractor or employee.

Many employers try to give employees independent contractor status to save on tax and benefits costs, which can increase the cost of hiring employees by 25% or more compared to contractors. For example, employers don’t pay unemployment tax or FICA tax for contractors.

However, some states, such as California, have passed laws to limit companies’ ability to classify workers as contractors if they perform tasks in-line with the company’s main business.

Many other laws that affect employees, such as anti-discrimination laws and the Americans with Disabilities Act do not apply to contractors. Contractors, because they are self-employed, do get some benefits, such as the option to open specialized retirement accounts like SEP IRAs.

What are the rights of an independent contractor?

Unlike employees, independent contractors have the right to control many aspects of their work, such as when and where they perform their tasks.

For example, a movie reviewer who contracts with a newspaper has the freedom to screen movies from their own home, at a local theater, at noon or at midnight. As long as they produce the review that the newspaper contracted them to write, how they accomplish the task is up to them.

However, independent contractors might not have some of the rights that employees receive, such as the right to non-discrimination protections or the right to receive minimum wage. They also aren’t eligible for things like workers’ compensation.

Ready to start investing?
Sign up for Robinhood and get your first stock on us.Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

1330280

Related Articles

You May Also Like

The 3-minute newsletter with fresh takes on the financial news you need to start your day.
The 3-minute newsletter with fresh takes on the financial news you need to start your day.


© 2021 Robinhood. All rights reserved.

This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Robinhood Financial LLC (member SIPC), is a registered broker dealer. Robinhood Securities, LLC (member SIPC), provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. All are subsidiaries of Robinhood Markets, Inc. (‘Robinhood’).

1771482