Pros and Cons of Being an Independent Contractor

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If you're the adventurous, entrepreneurial type, then working as an independent contractor might be a great career choice for you.

Independent contractors are sometimes called ICs, consultants, freelancers, free agents or just contractors. Regardless of the label, all are essentially the same in practice, including a self-employed designation when it comes to U.S. tax purposes. That's because the Internal Revenue Service has only two distinctions: an independent contractor or an employee.

While being an independent contractor comes with advantages over being an employee, there are drawbacks, as well. It's best that all workers, especially those considering independent contract work, understand the pros and cons of this classification.

Pros of Independent Contracting

As an independent contractor, you are your own boss. That's the main reason why people decide to set up shop in their home office as a freelancer. If you're a contractor who works out of a client's location, you might work shoulder-to-shoulder with the employees, managers, and bosses of the company you work with. But these folks are not your supervisors, they are your clients. As such, they may not direct your work as they might direct that of an employee.

Your clients can, however, require certain results in return for the fees they pay you. While you and your client will negotiate on the final product (and the pay for that final product) you alone decide when, where, and how the work is done. According to the Common Law Rules enforced by the IRS and the Fair Labor Standards Act issued by the Department of Labor, the difference between an employee and a contractor largely hinges on the degree of control and independence granted by the client.

As an independent contractor, you'll usually make more money than if you were an employee. Companies are willing to pay more for independent contractors because they don't have the enter into expensive, long-term commitments or pay health benefits, unemployment compensation, Social Security taxes, and Medicare taxes. Independent contractors also may deduct more business expenses than employees typically can claim. Unlike employees, independent contractors are required to withhold their own federal, state, and local taxes.

Cons of Independent Contracting

Employers like contractors because they can avoid paying for taxes and benefits, and that means those costs fall entirely on independent contractors. Contractors must withhold their own federal, state, and local taxes. They may also have to submit quarterly estimated taxes to the IRS.

In most cases, contractors aren’t eligible for state unemployment benefits, because they're self-employed, and they must fund their retirement accounts. Health and liability insurance rates for self-employed individuals are usually higher than the group rates employers can secure for their employees. Some clients may require you to carry liability insurance.

Independent contractors typically provide their own tools. Companies generally can’t reimburse independent contractors for out-of-pocket expenses, so you should factor in those expenses when determining your rates. If your clients provide the tools, then one of the enforcing agencies might penalize them for misclassifying you as an independent contractor when you should have been classified as an employee.

Because of the issues that can arise around whether a worker is an employee or a contractor, some skittish employers won't hire contractors who use their social security numbers as taxpayer IDs. If an employer reports the earnings of a contractor under that individual's social security number, it can trigger a red flag to the IRS, which might undertake an audit under the suspicion that the employer is misclassifying employees as independent contractors to avoid withholding taxes and providing benefits. To bypass the problem, obtain a federal employer identification number (EIN) and submit that in place of your social security number. A state taxpayer ID (if required) can save you money by allowing you to buy items at wholesale and free of sales tax, provided you intend to resell the merchandise. Your local Small Business Administration Office can help you get started with this and other business matters, for free.

Tips for Being a Successful Independent Contractor

Setting up your own business as an independent contractor requires an investment of time and energy, but the risk can pay off handsomely. For those with a creative and entrepreneurial spirit, the rewards will be more than just monetary.

To help you network, gain expertise, and receive discounts on insurance and other self-employment expenses, consider joining professional organizations such as the National Association for the Self-Employed. You'll also find a bevy of resources at the U.S. Small Business Administration's website. When you’re starting, apply to agencies that can connect you with contract work. Remember, though, that these agencies may withhold taxes and collect other deductions from your paychecks, depending on your working relationship with the firm. Agencies may also charge you a commission, which will reduce your compensation (although you can deduct it on your tax returns).