The Executive Suite: Working as an Independent Contractor

While seeking and employing alternative work arrangements in response to economic, technological and social changes, workers with an entrepreneurial spirit and wise U.S. employers have created more opportunities for independent contractors than ever before.

If you're the type of person who likes to settle in and dislikes ever-changing working conditions, then a so-called "permanent" job might suit you better. But if you're the adventurous, entrepreneurial type who likes new challenges, then working as an independent contractor might be right for you.
Independent contractors are sometimes called ICs, consultants, freelances, free agents and just contractors. Regardless, all are self-employed for tax reasons in the U.S. and essentially the same in practice.

But, speaking of tax reasons, the IRS has only two distinctions: independent contractor or employee.

The UpSide

As an independent contractor, you are your own boss. That's the main reason why most employees turn independent contractors. Even though you might occupy office space and work shoulder-to-shoulder with employees, companies are not your employers per se, but your clients. As clients, they are not entitled to direct you in your work like an employer may direct an employee. In other words, clients "hire" your services, not you.

Naturally, your clients are entitled to state the results they expect for the rates you're charging for your independent contractor services. It's also in your best interest to satisfy your clients, if you wish to receive favorable referrals for landing more contract jobs. But you decide when, where and how to work to get the job done. It's all about degree of control and independence, according to the Common Law Rules enforced by the IRS and the Fair Labor Standards Act enforced by the Department of Labor.

Independent contractors usually make more money than employees. Companies are willing to pay more for independent contractors because they don't have the expensive, long-term commitments they do with permanent employees, such as benefits, unemployment compensation, and Social Security and Medicare taxes. Independent contractors may also deduct more business expenses than employees, which might sweeten your net pay.

Independent contractors "withhold" their own federal, state and local taxes, unlike employees. This gives you the option of "working the float" on your gross pay, until taxes are due. For example, you might bank it to earn interest.

The Downside

Independent contractors don't have the same job security as employees, if there is such a thing anymore. The gold-watch-reward days of our grandfathers are pretty much a thing of the past. But even in a slowing business climate, employees continue to get paid. In really bad times, employees who survive layoffs continue to get paid and those who don't may at least collect meager state unemployment insurance benefits to survive.

Independent contractors are usually among the first to get the axe when slowdowns and layoffs occur. Independent contractors typically aren't eligible for state unemployment benefits, because they're self-employed. (If you work as an independent contractor and employee, you might be entitled to unemployment benefits if you lose your employee job.) Contract jobs might be fewer, and you might find yourself competing more, bidding lower, and going without work for awhile. Even worse, you might have to temporarily go back under the corporate thumb as an employee.

Independent contractors don't get free benefits and perks as do employees. You'll have to pay yourself for sick leave and vacation, fund your own retirement accounts, and among other things, buy your own health, dental, disability and life insurance. Insurance rates for self-employed individuals are usually higher than what employers pay per employee at group rates. Some companies may require you to carry liability insurance before hiring your services.

Since companies don't withhold taxes for independent contractors, you are solely responsible for filling out the paperwork and paying your taxes on time, every time, including self-employment taxes. Typically you'll pay estimated taxes quarterly, in lieu of employer withholding.

According to government guidelines that regulate employment relationships, independent contractors typically provide their own tools. If companies provide the tools, then one or more of the enforcing agencies might "punish" them for misclassifying employees as independent contractors if other factors don't offset it. Consequently, you'll likely have to make an initial or ongoing investment in tools (e.g., computer hardware and software upgrades) at your own expense.

The same goes for employee-like expenses, such as travel and entertainment. Companies are generally not allowed to reimburse independent contractors for such expenses, because it indicates an employer-employee relationship more than a client-IC relationship. If you incur such expenses, they'll likely come out of your own pocket. But it's acceptable to consider all of your expenses when calculating the blanket rates you'll charge for your services.

Speaking of misclassification, some employers naively don't understand the difference between employees and independent contractors. They treat independent contractors as employees, which defeats the reason you became an independent contractor in the first place: to be your own boss. Other employers are fully aware of the difference. But they attempt to exploit independent contractors as employees anyway, because it's clearly to their advantage to do so. In either case, it's a common "con" of becoming an independent contractor, even though it violates your rights as an IC.