If you are someone who is somewhat familiar with the business world, then you might have heard the terms sole proprietor and independent contractor at some point in your life. Although both terms are used to define individuals which are self employed, there are notable differences between the two designations. If you or someone close to you is self employed, you might have wondered which category you fall under. The nature of your business, your setup and the way you run your business ultimately decide whether you are a sole proprietor or an independent contractor. Individuals falling in these categories operate their businesses independently. Neither sole proprietors nor independent contractors have formal business setups in the shape of a corporation or a company. The difference arises in the way they are taxed.
Individuals in both categories have to pay self employment taxes through the schedule C IRS form. These forms are filled to report how much money you have made or lost as a self employed individual. Small business owners, people with side gigs, contractors, freelancers etc. attach these details to their tax return form when filing their taxes. Another difference between the two categories is how they earn their income. Independent contractors usually complete tasks for their customers for a set amount of money. Although sole proprietors also adopt this approach, they may also pursue other venues for generating revenue like selling their own products. If you are someone who is self employed, then it is not compulsory for you to pick one category and stick to it. There are many people that usually flip flop between the categories instead of sticking to one. The rise of globalization and the internet has made it possible for many people to start their own small businesses. Self employment usually gives you a lot of flexibility in terms of how you manage your business, how you setup deals with your clients and how many hours you want to work per day. With that said, let’s take a deep look into the differences between a sole proprietor and independent contractor:
What is a sole proprietor?
A sole proprietor is any individual who starts his own personal business and doesn’t register it with the IRS or the state as a corporation or limited liability company (LLC). Any revenue that you generate through this way will be considered your personal income by the IRS. As stated above, a sole proprietor ahs to report his business gains, expenses and losses through the schedule C IRS form along with 1040 from when filing taxes. These self employment taxes also include social security and Medicare taxes. Usually self employed individuals have to pay 15.3% of their net income as tax. If you register yourself as a corporation to the state, then you would have to file both personal and corporate tax returns essentially doubling the amount of taxes that you have to pay. Being a sole proprietor provides you the advantage of avoiding this. However, being a sole proprietor also means that you are personally responsible for any business debts that you may sustain. In case a sole proprietor fails in paying off the debt, his personal assets can be targeted by the creditors.
What is an independent contractor?
An independent contractor is someone who offers his services to clients as an autonomous body rather than being a full time employee of any organization. Independent contractors are not bound to any one client or company but work for several clients on a contract basis. The details regarding what needs to be done, how it will be done, the time period during which the work should be completed and the amount that will be paid to the independent contractor are all worked out in the contract. Independent contractors include freelancers like blog writers, web and graphic designers, IT consultants etc. One can argue that having a full time job has its perks like work space, financial stability, steady flow of income etc. but being an independent contractor allows more freedom than your typical everyday 9 to 5 job. Independent contractors can tackle jobs they want to perform while avoiding any they might consider a hassle. They even enjoy clients that give them free reign in terms of which method they want to use to achieve a given task.
An independent contractor pays self employment taxes through a 1099-MISC tax form. An independent contractor receives a 1099-MISC tax form from all the different customers and companies he has worked for in the calendar year. All the self employment taxes must be paid from these forms. Although they enjoy their freedom, being an independent contractor also has its downsides as well. A full time employee only pays half of his social security and Medicare tax. The rest of these expenses are covered by the company they are employed under. On the other hand, an independent contractor has to cover the entirety of these expenses on his own.
From above information, it can be deduced that both sole proprietor and independent contractor are self employed individuals rather than employees. Therefore, they don’t receive a monthly salary and their monthly income depends upon the number and type of work they did each month. Though we have already explained the key differences between the two terms, the following are the things that are similar between the two groups:
- Both sole proprietor and independent contractor are self employed individuals rather than being employed by other people. They work for different clients mostly on contractual basis and their income depends upon how many task they are able to accept and complete in a given time period. Being self employed, they enjoy more freedom in many aspects of their work unlike a company or corporation employee.
- Both sole proprietor and independent contractor do not register their business with the state or IRS. People in both categories have to pay self employment taxes. They do so through the schedule C IRS from. Details like business income, business expenses and losses are added to this form which is then attached to the tax return form when filing taxes.
- Both sole proprietors and independent contractors keep their business expenses separate from their personal expenses. Keeping your business expenses separate from your personal expenses is essential for the success of your business and for maintaining financial stability in your personal life. Sometimes it might be tempting to spend some of your personal money to give your business a little bit of boost. Practices like these are not healthy and might prove to be harmful to your business in the long run. It is always better to treat your business as a n independent entity.
Conclusion: Which one should you be?
If you are someone who is about to start his own small business alone, then you might have some questions like how should you build your setup? How will you handle your day to day operations? Should you be an independent contractor or a sole proprietor? The good news is that you don’t have to stick to any one category. There are many people who work both as independent contractors and as sole proprietors. No matter which category you pick, you would have to run your business by yourself, mange all the expenses and pay self employment taxes. How much you make will depend upon your work ethic and how many projects you can tackle at any given time. Being alone also means that if you get sick, there would be no one to cover your back. At the end of the day, both categories give you more freedom in your work as compared to a full job at any business firm. In short, working as a sole proprietor or an independent contractor gives you an opportunity to earn individually or to make some extra money on top of having a full time employment.