Is Being an Independent Contractor Worth it?
By Mack Bekeza, CFP®
One of the most significant rights someone has in the United States is the ability to pursue happiness and can bear almost any “how” in terms of getting there. With that said, many people value being their own boss and live an “eat what you kill” lifestyle. However, being your own boss carries many risks and can be nerve-racking for those who value security over pursuing a venture that can be highly rewarding. With that said, people can become what it is called an “Independent Contractor” or “Freelancer” to make a living for themselves. But what exactly does it mean to be an Independent Contractor?
What is an Independent Contractor?
Per the IRS, “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.” Independent contractors are typically people with a specialized skill set and do not need to be trained by the payee to get a particular job done. For instance, most doctors, lawyers, accountants, financial planners like myself, and other specialists are independent contractors. Because it can be less expensive to hire an independent contractor, companies occasionally use this type of hiring solely to cut their costs (mainly to avoid things such as paying employment taxes and benefits). To combat this, the IRS has provided guidance to confirm whether someone is an employee or an independent contractor. Are you working as an independent contractor and curious if you should be classified as an employee to have extra security and benefits? If so, you can click here to see the IRS’s article.
But is being an independent contractor all that bad? Below are the pros of being an independent contractor.
Pros of Being an Independent Contractor?
- Being “Your Own Boss”: Being able to set your work schedule and have a higher degree of autonomy can be fantastic for people who consider themselves to be independent and do not appreciate being micromanaged for everything they do. Since independent contractors have the same tax status as a sole proprietor, they can open special retirement accounts such as a SEP IRA and can possibly contribute more money on an annual basis towards retirement as opposed to a regular IRA. But that is just one of the benefits of being your boss.
- No Tax Withholding: When an individual or company pays you, the IRS does not require the payer to withhold taxes for independent contractors, meaning that you have full discretion over your entire gross income. In terms of tax forms, the payer is only obligated to send you something called a Form 1099-Misc at the end of the year if you earn $600 or more with them.
- Business Expenses are Deductible for Tax Purposes: Do you drive a lot and have to buy business supplies and tools? If so, you can deduct things such as how many miles you drive to your projects, buying office supplies, and much more. However, please speak with a tax professional to see what exactly you can deduct for your situation.
- Potential to Earn More Income versus Being an Employee: Since independent contractors are usually hired for specific projects and or are highly skilled in their trade, companies are willing to pay independent contractors more than they would an employee (although not guaranteed).
Sounds great! But with great pros, there are always caveats.
Cons of Being an Independent Contractor?
- No Guarantee of Income: Because being an independent contractor is mainly living an “eat what you kill lifestyle” and may involve you obtaining and keeping customers; there is no guarantee that you will make money. And if you do not have a solid contract with the payer and did not complete a project on time, you may not get paid at all.
- You will have Business Expenses: You may be responsible for bringing your own equipment, which can be extremely expensive, depending on the job you are performing. Although you can deduct these expenses, you still have to fork up the dough to pay for the equipment.
- You are Protected under Fewer Labor Laws than an Employee would be: You are essentially an “at-will” worker and can be fired at any time the payer desires without warning or reason. Therefore, real job security does not exist for independent contractors.
- No Guaranteed Benefit Plans: As mentioned before, you are not entitled to things such as health benefits or other forms of insurance; you will have to provide those benefits yourself. However, you technically have more choices in those areas, so this is more of a double-edged sword rather than a con.
- You are subject to Self Employment Taxes: Since the payer is not obligated to withhold taxes for you, nor do they have to pay employment taxes, that means that you will be responsible for making sure those are paid to the IRS. As of 2020, an employee only pays 7.65% for FICA, while an independent contractor will have to pay 15.3%!
- You will be subject to making Quarterly Tax Payments: One of the challenges of being self-employed is that you will subject to making quarterly tax payments. And if you underpay on your quarterly payments, you will be penalized when you file your annual tax return. In other words, you should hire an accountant and or purchase book-keeping software to maintain your books for you to make accurate tax payments.
Weaving it all Together
As you can see, being an independent contractor can carry high rewards but will potentially have to bear a lot of risk and expenses, just like a business owner would. So…are you thinking about becoming an independent contractor? Is it worth it to you?