Why does legal employment status matter?
So you’ve started freelancing. You’ve got your first few clients, and you’ve begun billing. One of them asks you to fill out your tax information for a 1099 before you begin work together. And suddenly you start to wonder—am I technically an independent contractor? Or am I self-employed?
When you don’t have a traditional job, you may not be sure how to classify your work. Yet it’s important to understand your employment status so you can take the right steps to establish a legal business, file your taxes, and protect yourself from risk.
Read on to learn everything you need to know about being an independent contractor vs being self-employed.
Independent contractor vs. self-employed
All independent contractors are self-employed, but not all self-employed people are independent contractors.
Becoming an independent contractor is one of the many ways to be classified as self-employed. By definition, an independent contractor provides work or services on a contractual basis, whereas, self-employment is simply the act of earning money without operating within an employee-employer relationship.
The difference between being an independent contractor vs self-employed is small but is important to understand when beginning your business. Independent contractors tend to be hired by a third party to complete specific work or projects determined by a contract. In comparison, self-employment can expand beyond this.
While some self-employed individuals are independent contractors, others:
- Own businesses
- Run startups
- Own retail stores
- Hire employees
- Hire independent contractors
It’s similar to the difference between freelance vs self-employed. All freelancers are self-employed, but not all self-employed people have multiple clients.
Let’s take a look at a scenario where a self-employed worker may not be an independent contractor.
Say you’re a graphic designer who works for clients on a contractual basis. You produce designs for T-shirts and other apparel, and you’re paid on a 1099. You’re an independent contractor—and you’re self-employed.
Now, say you’re a graphic designer who runs an Etsy shop. You produce designs for T-shirts and other apparel, and you sell them directly in your Etsy store. You’re self-employed—but you’re not an independent contractor.
As you can see, you can be self-employed without being an independent contractor. You can also be self-employed and make some money through a store or a business you own, while also doing independent contracting work.
So what difference does it make whether you’re an independent contractor vs self-employed? If you work on your own, not much at all. In both cases, you need to take the same steps to protect your business with the right business structure and business liability insurance.
What is an independent contractor?
First, let’s define independent contractors. The IRS states that:
“The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”
To put it in simpler terms, an independent contractor does work based on a contract, but the person or company paying them does not manage or oversee their work. Thus, there is not a traditional employer-employee relationship. It follows that:
- If someone is paying you to achieve a specific result, but you’re overseeing and managing the work/process yourself, you are an independent contractor.
- That individual or company should give you a form 1099 MISC at the end of the year for tax purposes.
- You’re responsible for paying taxes on the work that you did as an independent contractor (since the payer did not withhold taxes).
The IRS definition continues, “If you are an independent contractor, you are self-employed.”
What is self-employment?
To be classified as a self-employed individual, that individual is earning income while working for themselves. Self-employed individuals do not work in an employee-employer relationship.
According to the IRS, a self-employed individual can be defined by one or more of the following:
- Someone who is in business for themselves including part-time entities
- Someone who carries out business as an independent contractor or sole proprietor
- Someone who is a member of a partnership that conducts business or services
Common self-employed business structures
When you’re self-employed as an independent contractor (or otherwise), you’re responsible for paying your own taxes, and for protecting your business from risk.
To prepare yourself for tax season and protect yourself from liability, maintain good accounting practices to keep your business expenses and income separate from your personal income and spending.
Additionally, you need to decide how you’re filing your taxes as a worker and what your employment status will be. This comes down to how you structure your business. There are two main types of business structures for someone who is self-employed, a sole proprietorship and an LLC.
Sole proprietorship – this is the default business entity for self-employed individuals. If you don’t register your business with the state, but you separate your business earnings from your personal earnings, you have a sole proprietorship.
LLC (Limited Liability Corporation) – creating an LLC provides some protection from liability (as the name suggests). If a client or employer were to sue you, they could only come after your business assets, not your personal assets. When you form an LLC with your state, you’ll receive a federal tax ID.
This is a broad overview of the two structures, learn more about a sole proprietorship vs. LLC to help make the best decision for your business and finances.
When it comes to filing your taxes, the steps are similar for single member LLCs and for sole proprietorships. Either way, you know you’re fulfilling your legal obligations as a taxpayer and taking some steps to protect your personal finances.
The next step? Business licensing requirements.
Business licensing requirements
Depending on your type of business, you may need to look into specific licensing requirements in order to fulfill safety and zoning expectations required by your state. Explore some examples of licenses that may be applicable to your business:
Businesses that require licensing:
- Electrical, Plumbing & Construction
- Cosmetic services
- Controlled weapons or substance sales (guns, alcohol, tobacco)
- Food & Beverage
Businesses that don’t require licensing:
- Writing content
- Graphic design
- Handmade crafting
- Web or application development
As always, be sure to check with local laws and requirements for business licensing in your area.
Business insurance for independent contractors
Whether you identify as an independent contractor or as self-employed, it’s important to have your own business insurance. Even if you’re doing independent contracting work for a company that already has insurance, you’re not its employee, so its insurance likely does not cover you. This means that when you’re on the job, you could be held liable and named independently for things that go wrong.
From slip and fall incidents to claims of negligence or libel, every profession carries inherent risk. When you’re self-employed, a single claim could put your business (and your personal finances) at risk.
Depending on your line of work, you may need one or both of the following policies:
General liability insurance can help cover client and other third-party claims against you arising from personal injury, advertising injury, bodily injury, and property damage.
Professional liability insurance can help cover claims against you arising from errors and negligence that directly result in a client’s financial loss.
Which do you need? All independent contractors can benefit from general liability. If you provide others with professional advice as part of your services, such as marketing, you probably need professional liability, too.
If you do independent contracting work on the side of another job or are just starting out on your own, you may not want to buy an expensive annual policy. Some of your jobs might only take a few weeks, or even a few hours. In these cases, year-round insurance just doesn’t seem worth it.
Yet it’s still important to protect yourself from risk. That’s why Thimble created on-demand insurance. With our revolutionary on-demand freelance insurance you can take out insurance by the hour, day, or month.
And, getting a policy takes less than 60 seconds so you can spend more time finding new clients than filling out insurance forms. Once you purchase a policy you’ll receive a Certificate of Insurance right away.
Grow your business as a self-employed worker
When you’re an independent contractor, you manage your own affairs. That grants you a lot of leeway in when and how you do your job. But with freedom comes responsibility. Since you’re self-employed, you have to protect yourself from the risk you take on in your day-to-day work. To prepare yourself:
- Practice good accounting, separating your business and personal finances
- Understand your business type and file your taxes accordingly
- Protect your business with insurance
When you’re protected from risk, you can fully enjoy your independence and focus on what matters most (growing your business).