Whether you’ve always dreamed of being your own boss and starting a business, or have recently been laid off and need to earn an income while you’re looking for new employment, you might want to think about being a consultant (someone who is self-employed).
Common terms you may have heard that essentially mean the same thing are independent contractor, free agent, freelancer, freelance worker, and sole-proprietor. No term is really more legally correct than another. The important difference is being self-employed vs. being an employee. In the legal field, we typically use the term “independent contractor.” Legally, you are an independent contractor if you offer your services for hire to the public, various people or companies hire you and pay you a fee, but you control how you do your work. Employers supervise not only the outcome, but also how an employee performs his or her job.
A key difference between employees and independent contractors is the payment of taxes. Employers must withhold income taxes from their employee’s wages, withhold and pay Social Security and Medicare taxes, and pay unemployment taxes. That is not the case with independent contractors. Independent contractors are responsible for and have to pay all their own taxes directly.
A common question is whether or not you can simply “make the determination” someone is an independent contractor. Be careful – it’s not that simple! There are several tests that need to be met to qualify someone as an independent contractor vs. an employee. Because there are important tax consequences of being an independent contractor vs. an employee, there is an IRS test. But even that test is not black and white. In determining whether a person is an employee or an independent contractor, you have to examine all evidence that relates to the degree of control the company doing the hiring has and the amount of independence the person performing the services has. Generally, there are three categories to look at:
Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Meeting the IRS’s test isn’t the only hurdle for determining whether someone is an independent contractor or an employee, though. You also have to look to federal and state law. For example, there are provisions in the Fair Labor Standards Act that address the issue. But there is no need to be overwhelmed. If you are considering becoming an independent contractor or hiring one, just talk to your legal and tax advisors. They will be able to help you make a quick determination.
Very often new or small businesses don’t need or can’t afford an employee who would expect a regular paycheck – so hiring a consultant (independent contractor) to help can be a great way to increase profits. For instance, if a business owner is doing their own bookkeeping, he or she isn’t out making sales calls or providing the services of the business. Meaning they aren’t making money for the business. But by paying a bookkeeper who can probably do the books faster and more accurately, the fees paid will be money well spent because the business owner is free to do what he or she does best.
Like every other contractual arrangement, put any independent contractor agreements in writing. If you are a going to be providing services as an independent contractor make sure you have a document that spells out all the details of your arrangement, including what you will be doing, what and how often you will be paid, and whether you will be reimbursed for any expenses. Look into whether you should have your own liability insurance (usually a very good idea even if the company hiring you says their insurance will).
If you are business owner and are bringing someone on as an independent contractor, make sure you have a clear written agreement that explicitly states the consultant is an independent contractor and not an employee and that he or she will be responsible for all their own taxes. Check with your liability insurance and see what coverage you may have for this person. Ideally you will want him/her to have their own coverage as well. Also, it is a good idea for the person to bill you for services rendered, rather than have them fill out a timesheet or keep track of their time in a manner typical of employees. And remember, if you are retaining the services of a consultant be watchful throughout your relationship and do not overstep boundaries by exerting too much control. Keep the relationship within the scope of the definition of an independent contractor. Otherwise, you could find yourself in trouble, as the IRS or state could come in and determine the person is really an employee.
If you do it right and are mindful of the rules, being or hiring an independent contractor can be a great way to make money – and who isn’t looking to do that these days?!