What is the difference between self employed and independent contractor

When you run a business, you need to consider costs and expenses, revenues, taxes, business structures, etcetera. A common question is how to carry on your business. But this isn’t only limited to sole proprietorships, partnerships, and corporations. Many entrepreneurs are further confused about whether they are independent contractors or self-employed.

Table of Contents Show

What’s the difference between independent contractors and self-employed individuals?
Insurance requirements for independent contractors versus self-employed
Tax considerations for independent contractors versus self-employed
APOLLO Has You Covered
What is an independent contractor?
What does “self-employed” mean?
Independent contractor vs. self-employed individual examples
4 things non-employees must have when working for you
1. A contract
2. Licenses
3. Insurance
4. Tax forms

This article outlines the differences between these roles and how insurance and tax considerations may come into play.

What’s the difference between independent contractors and self-employed individuals?

Unlike the frequent independent contractor versus employee debate, where someone is “either-or”, independent contractors are a subset of self-employment. Self-employment means you’re earning money without being someone’s employee, and this definition also fits independent contractors. However, not all self-employed people are independent contractors.

An independent contractor explicitly provides a service to someone on a contractual basis. You could be asked to design a logo, renovate an office, or sell a product as an independent contractor. However, suppose you’re selling a widget to anyone looking for it. In that case, you could still be self-employed but not an independent contractor because you’re not contracting with a specific client through your business process.

Related: Common claims every contractor should know

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Insurance requirements for independent contractors versus self-employed

There’s no “one-size-fits-all” solution. Self-employed people need insurance depending on their particular line of work. For example, a gym owner may need various liability insurance policies and property insurance. In contrast, an e-commerce entrepreneur who works from home may have different insurance needs.

This further applies to independent contractors. A graphic designer’s insurance needs, ultimately differ from a personal trainer’s insurance needs.

For independent contractors, it’s essential to understand the details of your client contracts. Some contracts require having specific insurance policies ready. Additionally, agreeing to an indemnity clause may mean you agree to cover any loss, damage, or liability suffered by another party (usually your client). As a result, signing an indemnity clause is a good reason to purchase liability insurance. Then, if a client exerts their indemnity-clause rights to cover any loss or damage, your insurance could cover the fallout. It’s best to speak to a lawyer or insurance broker to learn more.

Related: Does general liability cover independent contractors?

Tax considerations for independent contractors versus self-employed

Similar to insurance, the intricacies of your taxes differ depending on what your business does. As a self-employed person or independent contractor, you can generally deduct the expenses used to run your business, such as a laptop or phone or even the gas you use to get to meetings or worksites.

Independent contractors should be aware of what category they fall under, an independent contractor or an employee. If the Canada Revenue Agency (CRA) ultimately determines that you’re an employee of an organization and not a contractor, you could lose your ability to deduct expenses from your income. This can have a drastic effect on your after-tax income.

In determining whether you’re a contractor or employee, the CRA considers factors such as the degree of control the client has on you, whether the relationship is one of subordination, regularity of work schedule, and more.

If you’re self-employed (including independent contracting), you should see an accountant for more information on how you’re taxed and arrange your affairs in the most tax-efficient manner.

Independent contractors are ultimately a subset of self-employment. Regardless of your business or practice’s category, it’s crucial to figure out the proper insurance and tax implications to ensure you’re not liable to losses, damages, or unforeseen taxes.

Related: How much does general contractor insurance cost?

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Originally published July 15, 2021, updated October 24, 2022

All apples are fruit, but not all fruit are apples. That’s essentially the difference between independent contractors and self-employed workers. All independent contractors are self-employed, but not all self-employed people are independent contractors. For hiring purposes, you treat them the same: You don’t employ contractors; they technically employ themselves. However, contractors and self-employed people are not exactly the same thing. When working with both, you need to keep certain legal and tax compliance concerns in mind in order to protect your business and your workers.

What is an independent contractor?

An independent contractor is someone contracted by an individual or company to provide a service. Contractors, or freelancers, tend to be highly skilled in specific fields, often found in such industries as law, accounting, writing, art, programming, construction, and more. First things first: Contractors aren’t employees. In the United States, there are three key differences between contractors and employees, according to the Internal Revenue Service:

Behavioral control: How they work, including when and where. While contractors dictate how, where, and when they work, employees don’t typically have that freedom. When working with contractors, the payer can only control the result — the “what” — and not the means — the “how.”

Financial control: How they get paid, i.e., how much, how regularly, and through what means. Contractors generally dictate how they would like to be paid and how much. Employees are paid based on the employer’s payroll schedule and budget.

Relationship: A combination of factors, including the wording of any written contracts, the length and permanency of the work relationship, as well as whether benefits are provided. For example, employees generally receive benefits like healthcare and paid time off while contractors do not.

Misclassification is a real concern when working with contractors. Make sure that your contractors really are contractors and not employees misclassified as such. For more info on the differences, check out our Guide on Who to Hire: Contractor vs. Full-Time Employee.Contractors are often hired to fill short-term needs or complete project-based work, with the scope of work clearly defined in their written contract. For example, a social media specialist could be contracted to craft and schedule 10 posts by the end of each week for $2,000 a month.According to the IRS, “If you are a business owner or contractor who provides services to other businesses, then you are generally considered self-employed.” This is because even though independent contractors are paid by an employer, they technically work for themselves.

What does “self-employed” mean?

Being self-employed means that someone earns income by working for themselves instead of for an employer. Even if they’re paid by various people or entities, self-employed people must find their own work, without being guaranteed a regular salary.There are three common business structures that self-employed people tend to use when running their own businesses in the U.S.:

Sole proprietorship: The owner, or sole proprietor, is the business. The business is unincorporated, owned, and operated by one person. Their business income is considered personal income. Independent contractors and freelancers fall into this category.

Partnership: Two or more parties share ownership of a business. They divide its liabilities, responsibilities, and profits.

Limited liability company (LLC): A business entity that has one or more owners, called “members.” All members of the LLC are protected from personal liability for debts or legal issues.

Self-employed business owners manage their business expenses, including wages for any employees or contractors they choose to hire. Self-employed individuals are also in charge of calculating tax liability and paying their own taxes on time — quarterly for those owing over $1,000 per year. This includes a self-employment tax, paid in lieu of FICA tax (Social Security and Medicare taxes), as well as federal income tax and state income tax. They may also owe business taxes, depending on the scale of their small business.Workers enjoy being self-employed thanks to the independence of being their own boss and the freedom to choose their own work hours. There’s also no limit to the potential income self-employed people can earn versus a fixed salary they would earn as an employee. On the flip side, self-employed people have to motivate themselves to work and actively seek out opportunities because pay isn’t guaranteed. They can also run into tax issues when filing their tax returns, especially if they don’t work with an accountant. Additionally, self-employed people don’t receive employee benefits like health insurance, paid time off, and sick leave.

Independent contractor vs. self-employed individual examples

Remember our apples-to-fruit analogy? Maybe food isn’t the best comparison. Let’s look at more relevant examples that could help you figure out whether you’re working with a contractor or a self-employed person.Lawyer A is a semi-retired attorney who works on cases on an as-needed or temporary basis. She has over 30 years of experience in family law. She primarily serves as an “of counsel” attorney for law firms that occasionally consult her for her family law expertise. Lawyer A is an independent contractor. Lawyer B is a partner at a law firm. His firm seeks out and works with multiple clients year-round. He employs several associate attorneys to spread out the workload. The law firm publishes radio and TV ad spots to draw in more business. Lawyer B is self-employed.Artist A takes on occasional graphic design commissions on a contractual basis. He mainly accepts one-time projects here and there to design logos for various clients. He also works with clients for three months or more at a time to deliver more comprehensive graphic design packages. Artist A is an independent contractor.Artist B works on digital art full time and is a small business owner. She streams the art process on Twitch, earning subscriber and tip revenue from that platform, and posts the art on social media for marketing. She also operates an online storefront, from which she packs and ships print orders to customers. Artist B is self-employed.

4 things non-employees must have when working for you

When working with non-employees like contractors and self-employed workers, make sure you have a written contract, deliver all tax documents on time, and that you verify insurance and licensing requirements. These requirements may vary by country, so make sure to double-check which ones apply to the country you’re hiring in. These things will ensure that your business and its contractors are compliant with legal and tax regulations. These compliance concerns are the same whether someone is an independent contractor or self-employed.

1. A contract

Your employment contract details the relationship between you and your non-employee. It protects you both and spells out all the details of the work you’ll accomplish together.In your contract, define the scope of work. Specify the results or the deliverables you expect to receive from your contractor, as well as deadlines. Include the rate of compensation — usually determined by the contractor — and explain how you’ll pay them. You should also clarify their employment status, including the fact that they are a contractor, not an employee of your company. Define the length of your working relationship, whether it’s a one-time project or an ongoing engagement.For sensitive and classified projects, consider a non-disclosure agreement (NDA) or intellectual property transfer clause. Such clauses can ensure that your business trade secrets remain safe, and the work done by your contractor stays with the company. Since contractors use their own equipment and operate at their own cost, clarify whether or not they’ll receive reimbursement for business expenses, mileage, etc. Keep in mind that self-employed people can claim these expenses as tax deductions. You may also consider inserting a clause about termination. If either you or the contractor wishes to end your working relationship, this clause will outline how to do so.As contracts are legally binding documents, we recommend getting your contract reviewed by an employment lawyer. They can help you make sure it’s compliant with labor laws, especially if hiring across state lines or internationally. At Pilot, we have our clients’ contracts reviewed by both U.S. and local lawyers.

2. Licenses

The licenses self-employed people are required to hold depend on the work they perform and where your business is located. If they live in another state or country, the licensing requirements might be different. Common professions that require licenses include:

Cosmetology

Accountancy

Medical fields

Real estate

Social work

Education

It’s best to check with the state and/or local governing agency for an industry to find out which licenses are required in your area. Check with each non-employee to see what licenses or certifications they have and ask for proof of their license. In the U.S., you can then verify those provided license numbers through your state’s license database. Find your state here.

3. Insurance

Any self-employed workers who aren't in an LLC have personal liability while completing their work. That's why it’s important to confirm whether or not they have business insurance. You can require your non-employees to have insurance via a clause in your employment contract.There are many different types of insurance that small businesses and self-employed individuals can purchase. General liability insurance protects businesses from lawsuits accusing them of harming another party. Among other things, this covers bodily injury, copyright infringement, property damage, slander, and libel. Professional liability insurance, also known as errors and omissions insurance, covers any mistakes made in someone’s work. This includes breaches of contract that could damage a client. Other kinds of insurance often carried by contractors, depending on their needs, include commercial auto insurance, commercial property insurance, and cyber liability insurance.Some insurance types are more applicable or necessary than others for certain business owners, depending on the profession. For example, consider a freelance copywriter who works from their home office. They probably don’t need general liability insurance to protect themselves from the risk of injury on the job. However, they may want professional liability insurance in case something they write harms their client’s reputation.By U.S. law, self-employed people generally only need to have workers’ compensation if they employ others. However, if your uninsured contractors are injured on the job, you could be held responsible for their medical bills in some states. That’s why it’s important to make sure that your contractors have insurance and show you proof of insurance before beginning work.

4. Tax forms

Make sure you provide non-employees with the IRS forms they need on time or early when possible. If you fail to provide 1099s on time to your contractors or provide an incorrect 1099, you could face costly penalties. For example, most 1099 forms are due to recipients by January 31 each tax year, but sending 1099s earlier helps keep you ahead of any fines.Start by requiring a W-9 from any non-employee before you start working together. This will provide the information you need to fill out 1099s. For international contractors you work with, request they fill out a W-8 BEN instead of a W-9. Hold onto that W-8 BEN. This form will protect your business from tax audits because you can prove that the contractor didn’t owe taxes to the United States.Keep records of the total payments sent to a contractor throughout the tax year. Then, at the end of the year, be sure to fill out and send each of your contractors a Form 1099-MISC or Form 1099-NEC (the 1099 each contractor needs will depend on the nature of their work). Because self-employed individuals need to file their own tax returns, they need the information on those 1099 forms to file their Schedule C with the IRS.