Independent Contractor: What it Means & What To DoJul 25, 2021
You may be working for a company as an independent contractor but do you realize this means you are a business owner?
It's important to know if you are working as an independent contractor, you are in fact, a business owner. You can decide if you or the business works for more than one company, if it will have multiple revenue sources, how it is formed and structured and you get to manage it the way you want. You are your own boss! Being a business owner also comes with responsibilities and steps you need to follow to set up your business.
This blog covers what you need to know when working as an independent contractor for other businesses. There are significant more rules and factors to consider if you are hiring an independent contractor. For more information, see this blog: Employee or Independent Contractor: Factors and Decisions
If you are reviewing or plan to sign a contract for work, it is wise to consult with an attorney familiar with your state laws.
What is an independent contractor
An independent contractor is a business that contracts with another business for work. Here are some examples:
- An attorney with their own firm and 50 business clients is an independent contractor to each business client.
- A psychologist who performs an occasional evaluation for the client of another clinical private practice, and is paid by the private practice, is an independent contractor to the private practice business.
- A plumber who is self-employed and works for two large commercial properties is an independent contractor to each property.
- An individual who does fix-it work for several businesses and isn't employed by any of them, is self-employed and an independent contractor.
From an accounting and tax standpoint, there is no difference between an independent contractor and any other business owner. Businesses regularly contract to hire professionals such as attorneys, accountants, business coaches, plumbers and painters, and those professionals are operating their own separate business while under contract.
Typically an independent contractor will provide an invoice, statement or work order detailing the work performed and the cost in order to get paid and the contractor decides if they want to accept payment via cash, check or credit.
If you are working in a situation where the business tracks what they owe you without an invoice or other paperwork, it's a good idea to still track what you earned and keep that for your own records. This will ensure you are paid for all the work you have completed.
A business you contract with is limited to how much they control your activities. They can have standards for the work you are performing. But they do not get to be involved in your other business activities, cannot tell you how to set up your business and cannot limit your ability to offer services to the general public. You are responsible for ensuring you have the training necessary to do the job and you usually get to control how, when and sometimes where the work is done. You may even control who does the actual work.
For example, if you hire a painter to paint an office space light blue, you can certainly choose the color and determine if the work was done satisfactorily, and you can say they can't work before or after a certain time if the office is not open. But you can't prevent them from using one of their employees to do the bulk of the work, can't require they show up at a specific time or determine when they can take lunch. And you would not pay for the painter get training on how to do the job.
Likewise, if you hire an accountant to prepare a tax return, they would do the work in their own office and could use a staff person on their team to do the work. You would not train them to do the return, and you wouldn't determine their work hours or how much time they spend on it. Their responsibility is to provide you with a completed, timely, accurate tax return and that end result is the part you have a say in.
As a business owner, ensure you retain control over your business operations even when you contract with someone else for work.
Although you have fewer concerns working as an independent contractor than if you are hiring an independent contractor, it's a good idea to understand how these rules work in general.
Generally, it is the hiring business who bears the risk if found to have an employee who is improperly classified and paid as an independent contractor. They can be made to pay back taxes, interest and penalties.
Contractors themselves need only to be sure they are permitted to be self-employed. For example, a professional working toward state licensure may be under the rules of a licensing board that require independent business owners to be fully licensed. If you have any limitation for practicing independently, you cannot be an independent contractor.
Federal and state laws can change. If working as an independent contractor, you might wake up one day and learn find that the business you were contracting with needs to hire you as an employee given the nature, type, and extent of the work being performed, simply because the state has created more stringent rules. Be aware how you can be impacted by reading more in this blog: Employee or Independent Contractor: Factors and Decisions
Multiple revenue sources
If you work under a contract for multiple businesses, you do not need to create a separate business for each source of revenue. It is common for businesses to have multiple sources of revenue.
For example, a financial retirement consultant with direct clients can have a contract with a business to come in twice a year and offer retirement tips to their employees. Or a psychologist can have their own private practice and also a contract with another group practice to occasionally perform psychological testing for clients of the other practice.
Since the work being performed in each case is similar, it would be one business with multiple sources of revenue. The business owner/contractor would then pay their business expenses from that one business, set aside money from taxes and pay themselves from the business. Services or sales do not have to be identical to be captured within the same business. They only need to be similar or somehow related.
However, if a contractor provides two very different services, they might need to be treated as two separate businesses. For example, if an attorney has a law firm and then creates a side business contracting with other companies to resell discounted office supplies, that is likely going to be an entirely separate business venture. The business supply activities likely need to be set up as a different business which means separate business name, banking and accounting.
Steps to set up the business
If you begin working as an independent contractor you have all the same business type decisions to make as someone entering private practice. You will want to:
- Choose your form of business
- Get an Employer Identification Number (EIN)
- Open a business bank account
- Choose an accounting system
Do not skip these steps. Where an employee can have their paycheck deposited straight to their personal account, a business owner needs to have revenue deposits in a business account. There needs to be separation between the business activities and the owner's personal transactions.
Follow the Simple Profit 10 essential steps to starting your business to get your business started.
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