Did you ever wonder what an independent contractor is? The term independent contractor refers to a self-employed individual who works under contract to provide services to a paying company.
Independent contractors come in many shapes and sizes. While some contractors charge by the hour for their work, others charge per job or project. There are those who focus on short-term projects, while others pursue long-term commitments. It is also likely that they will work with more than one company at the same time.
As the gig economy rises and remote work becomes more mainstream, the number of independent contracts is steadily rising. Almost one-third of workers have worked for themselves, while 14% primarily work as an independent contractor.
This is part of an extensive series of guides about workforce management.
How are they different from freelancers and gig workers?
Freelancers, independent contractors, and gig workers are all types of self-employed workers, which means all of them have to pay self-employment taxes (more on that below), and none receive employee benefits or protections.
While there are similarities between them, there are key differences in the nature of work for each group.
What is an independent contractor?
Like all self-employed workers, independent contractors can pick and choose which projects they want to work on. They can take multiple short-term jobs, but it’s more common that they opt for longer-term work arrangements with one or two clients. Because of this, most are paid by the hour.
Among those that work with a single client, some independent contractors will actually come to the company’s office, work side-by-side with employees, and even have a workstation. They are also more likely to be added to a company’s internal communication platforms, such as Slack.
Common examples of independent contractors are doctors, dentists, contractors, accountants, and real estate agents.
What is a Freelancer?
Like independent contractors, freelancers determine their own rates and specify if they will be paid by the hour or per job.
However, most of the time they work remotely. In pre-Covid-19 days, freelancing gained greater popularity when the “digital nomad” concept was born, in which individuals performed their work while traveling or living in different parts of the world.
Another difference between freelancers and independent contractors is the duration of work. While both are considered temporary arrangements, freelance work tends to be shorter in scope. Because of this, it’s more common for freelancers to work with multiple companies at the same time.
Many freelancers find their work via word-of-mouth referrals, as well as freelancer marketplaces such as Fiverr and Upwork. Writers, programmers, graphic designers, tutors, and photographers are common examples of freelancers.
What is a Gig worker?
Although gig workers will be legally classified as independent contractors, they get their own category here because the nature of their work is different from traditional contractors.
Gig workers perform temporary, very short-term jobs — often procured through a consumer-facing app — to provide on-demand services. The most common types of gig workers are ride-hailing app drivers (i.e. Uber and Lyft), food delivery drivers, and other services that can be ordered online, such as furniture assembly via Taskrabbit.
What are the tax requirements for working with independent contractors?
In the US, each individual’s tax requirements are based on how they are classified: self-employed or employed. According to the IRS, a person is self-employed if the payer “has the right to control or direct only the result of the world and not what will be done and how it will be done.”
Independent contractors are required to file an annual return and pay estimated tax quarterly.
When income tax season arrives, American paying companies need to send independent contractors a Form 1099-MISC, which reports all of the income paid to the worker in the previous calendar year. This form takes the place of a W2.
If an independent contractor’s net earnings were $400 or more, they will need to file a tax return with the IRS on a Form 1040. They will also file a Schedule C to calculate net income or loss for their business.
All self-employed workers are required to pay Self Employment Tax, which pays into Social Security and Medicare.
4 benefits of hiring independent contractors
Competitive businesses have already identified the value of building up a strong alternative workforce. Here are four benefits of working with independent contractors.
#1 Access to top-tier talent
Many of the most qualified and experienced workers opt to work for themselves to gain the benefit of autonomy and flexibility in their work. By supplementing your workforce with independent contractors, you’ll be positioned to fill crucial skills gaps and tap high-demand industry expertise.
#2 Increase agility
A robust alternative workforce empowers you to be more agile, nimble, and adaptable amid unpredictable markets and shifting regulations. Because independent contractors work on a temporary basis, your relationship with them is more flexible. This allows you to change business priorities, build new strategies, and connect with the right talent fast.
#3 Quicker onboarding
Onboarding a full-time employee can take weeks or even months. When you have a project that you want to dive into fast, getting an independent contractor up to speed is much quicker. With them, you can focus on the project itself and ignore the organizational and cultural components of onboarding.
Occasionally, a company will want to include vetting and background checks in the onboarding process for sensitive roles, but it is rare.
#4 Cost savings
Even though some independent contractors require hefty payments, there are far lower overhead costs compared to hiring full-time employees. With self-employed workers, employers are not required to subsidize health plans, contribute to unemployment or retirement, provide minimum wage, or offer paid time off. There is also a lot of flexibility when it comes to how to pay contractors.
4 disadvantages of working with independent contractors
There are also drawbacks to be aware of when working with independent contractors.
Disadvantage #1: More frequent talent hunt
Because an independent contractor’s tenure will be shorter than a full-time employee, backfilling them requires a more frequent talent search, which can be tedious and time-consuming. With so many freelance marketplaces today, it can feel impossible for hiring managers to identify and vet the best talent for a job.
Disadvantage #2: Commitment issues
It is in the best interests of independent contractors to select the jobs that will pay the most, offer the most interesting work, and satisfy their other requirements. That means they move easily from one job to another with minimal commitment.
Disadvantage #3: Lack of control over the work
While employees can dictate exactly how employees do their work, they don’t have this oversight with self-employed workers. Payers need to be comfortable with a more hands-off work relationship when working with independent contractors. In many cases, it’s up to the employer to ensure the tools and processes of the freelancers are meeting with the different regulations the company must meet.
In some cases the company also must ensure the freelancer have a third party insurance and get an insurance for them, to protect their customers and the company due to the inherent lack of control.
Disadvantage #4: Risk of misclassification
Misclassifying independent contractors can lead to costly consequences from the IRS, including penalties and back taxes. Unless you have a system in place to guarantee classification, working with independent contractors introduces your company to added risk.
What are independent contractors’ role in the future of business?
In order to determine which type of worker is best for a given situation, businesses must weigh the pros and cons of different types of workers. It is clear, however, that building a robust alternative workforce is an advantage for businesses that want to increase agility and get an edge over their competitors.
Having a strong network of independent contractors as a company grows will give them a decisive edge in a competitive, unpredictable, and fast-paced market.
See Our Additional Guides on Key Workforce Management Topics
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