There are various roles today that offer an alternative to the traditional employer – employee relationship. With the availability of freelancers, part-time workers, and independent contractors, companies are becoming more reliant on these alternatives. Independent contractors have especially become more common. While companies that use independent contractors do enjoy many benefits, there are also proportionate risks that are involved. We explore all the important information you need on independent contractors, as well as the advantages and disadvantages of an independent contractor.
What is an Independent Contractor?
Contrary to a full-time employee, an independent contractor is a person or entity that is self-employed, who is contracted to perform a service to another entity. During the period the contractor is delivering the service, they are not considered an employee of the entity that contracted them (Investopedia).
Due to the contractor not being an employee, the contracting entity is not required to provide the contractor with employee benefits, such as the relevant social security contributions. This means the contractor will be responsible for covering their own benefits like health insurance, unemployment contributions, and any other contributions an employee may be entitled to.
The scope of an independent contractor has become wider over time. Previously applying mainly to doctors, lawyers, and other professional services. Now it applies to freelancer type roles, such as writers, photographers, designers, and more.
An Independent Contractor Vs Self Employed
After understanding what an independent contractor is, the next question many people ask is if it is the same as being self-employed. Being self-employed means that you do not earn money by working as an employee for someone else, meaning you are your own boss. Therefore, someone who is a freelancer or independent contractor is self-employed.
While a freelancer may hire their services out to different companies, those companies are not their employers. As a freelancer you provide your services to the company on a contractual period for a defined period of time.
An independent contractor can be classified as self-employed but being self-employed does not necessarily make you an independent contractor. In the case of entrepreneurs and small business owners, they are considered self-employed but cannot be considered independent contractors.
Benefits of an Independent Contractor
Benefits of Being an independent contractor
If you currently are or you are considering becoming an independent contractor, here are the advantages:
- Less income tax – Independent contractors generally pay less income tax than full-time employees. This occurs mainly because certain taxes are withheld for employees and not for contractors. As such, reporting income taxes for contractors is different than it is for employees. Contractors and freelances need to ensure that they pay their taxes on time otherwise it may result in penalties being imposed.
- Earning potential increases – As a freelancer/independent contractor you could increase your earning potential, often making more than employees working in the same role of a particular company. The potential for earning more is increased because employers do not have to make any long-term commitments, as well as not having to make any social security contributions.
- You are the boss – Independent contractors carry out work for other entities, however they are for all effective purposes, their own boss. As a contractor you decide when, where, and how you want to work. Unlike a full-time employee who has little room to refuse work, a contractor decides which work they take on. An independent contractor takes all the risks and rewards, and their value is dependent on the quantity and quality of the jobs they get.
- Increased flexibility – Contractors are generally not tied down to 1 particular entity. As your work would be more project based, which may allow you to take on multiple projects simultaneously. This gives you more flexibility and freedom, and you can determine how many hours you want to dedicate and where you want to work.
Benefits of Using an Independent Contractor
For a company considering using an independent contractor, these are the benefits:
- Saving in costs – Even though an independent contractor may receive more money per hour than a full-time employee, you are not required to make any social security contributions. This means that the overall cost for the contractor may work out cheaper.
- More flexibility – By using freelancers or contractors your business can decide when and how it wants to achieve the goals of specific projects. This means that you only have to focus your human resource efforts on specific projects, and the contractors can be offboarded once their contract has ended. Offboarding is generally more straightforward and easier than offboarding a full-time employee.
- Reduced risk and liability – when hiring full time employees, companies offer specific benefits and make certain contributions. Companies who do not do so may put themselves at risk of legal actions and repercussions. They are also responsible for severance and may be liable for wrongful termination under specific circumstances. Engaging an independent contractor allows companies to avoid liability and reduces the risk of fines or any legal repercussions.
- Project scaling – Your business can increase the size of a team based on a specific project, without having to keep staff onboarded full-time. This allows you to adapt your workforce based on the needs of your business. If a project requires a niche or technical skill, that other projects do not, you can outsource this function to a freelancer to help achieve your targets.
Disadvantages of an Independent Contractor
Disadvantages of Being an Independent Contractor
If you are considering being an independent contractor here are the disadvantages that may come along with it:
- Additional responsibility – While there is a lot of freedom that comes with being an independent contractor, there is also a great deal of responsibility that comes with it. While employers don’t need to pay taxes and social contributions, the duty thus falls on the contractor. Contractors must ensure they correctly pay their own taxes and make the relevant contributions. As a contractor you have to fulfill many roles. You are responsible for your own marketing, finances, and operations.
- Limited access to resources – If a freelancer or contractor generally needs access to specific tools or resources, businesses in most cases may not reimburse the freelancer for expenses incurred. You will need to ensure that you have access to all the required tools and resources, which will be influential when determining your price.
- Limited job security – Employees generally earn a stable income each month, while the same is not applicable to independent contractors. You may be extremely busy in one period, and completely free in the next. While some contractors find steady clients, others have to constantly search for work. The work may also be seasonal and that would mean that you would have to prepare in advance in order to reduce risk.
- Finding a balance – For a lot of independent contractors they may have difficulty finding a balance between work and life. This is because the workload may differ from week to week and having a set schedule is challenging. Therefore, you have to be disciplined or comfortable with the shift in workload as it fluctuates.
Disadvantages of Using an Independent Contractor
There are many benefits to using contractors, but there are also significant drawbacks. Here are some of the cons of hiring independent contractors:
- Less stability – Because contractors and freelancers are used on a project basis, often these contractors will come and go. This can be disruptive in some capacity, as the quality of these workers may vary. Even when a company finds reliable, high-quality freelancers, they may not always be available to your business. If your business wishes to rely on the same workers for a long period, it may be better to hire full time employees.
- Less control – Unlike with full-time staff, your business will have limited control over independent contractors. Contractors enjoy a certain level of autonomy and if you exercise too much control over them and assign too much work, they can choose whether they wish to continue working with your business or not. Furthermore, if you treat them like employees, you be in contravention of labor regulations (if they look like employees and act like employees, they should be recognized as such). Not classifying employees correctly could amount to a misclassification of employees, and your business may be liable for a fine.
- Contractual restrictions – Like with any valid contract, all parties to the contract are bound to the terms of the agreement. The terms of a contractor’s contract are often less stringent than those included in an employer – employee relationship. It is important to include terms regarding the scope of the project, cases of termination, and ownership of intellectual property, among other things.
- Risk of Injury liability – Employees are generally covered by some sort of worker’s medical insurance or other health insurance scheme. In the case of independent contractors, they are generally not covered. As a result of this if a contractor is injured on the job a dispute may arise, causing a contractor to take legal action against your business.
Is it Better to be an Employee or Independent Contractor?
This question is quite subjective and really depends on a what you want both professionally and in terms of your lifestyle. Opting to be a freelancer or contractor does not only affect your professional career, but your personal life as well.
As a contractor you may make more money than if you were a full-time employee. However, the tradeoff is a potential lack of stability. If you are looking for stability or growth in an organization, being an independent contractor is not the ideal choice for you.
If more free time and more independent control is what you seek, taking the risk of being a freelancer may be more rewarding and beneficial to you. A good point of departure may be to be an employee before switching to an independent contractor. This affords you the opportunity to sharpen your skills through an enterprise, as well as build your professional network for when you do decide to go independent.
The more specialized you are in a particular industry or skill, the more demand there may be for your services as an independent contractor. Having a specialized skill or working in a niche market, puts you in a better place as a contractor.
Choosing whether to freelance or work full-time is a choice that needs to be made once you have looked at all the pros and cons of being an independent contractor and looked at it alongside what your goals are.
Tips for Being an Independent Contractor
Here are some helpful tips if you are considering becoming an independent contractor:
- Select the correct business structure
Selecting the correct business entity is important when setting up your business. The type of business structure you select has an impact on your scope of activities, responsibilities, taxes, and other obligations.
You have to choose the most appropriate entity for your scope of activities and business needs. Before going independent you should research the different types of entities available such as a Limited Liability Corporation or sole proprietorship (learn more about business entities and company incorporation here). Alternative options like a Professional Employment Organization (PEO) can also be a cost effective, easy option for contractors. Each country and jurisdiction may have different rules and requirements for setup.
- Determine how you want to run your business
Some integral elements of your business setup will include:
- Outline the set of services you will offer to clients.
- Draw up the plan of what you will charge and why.
- Choose a good system for your bookkeeping and invoicing.
- Find out how to pay your taxes
- Determine which social contributions you need to make.
- Find out if you need to take out any insurance policies.
- Get access to any tools or resources you may need to carry out your services.
- Develop and execute your marketing strategy
As an independent contractor you should aim not only to seek new customers but also look for projects you may be interested in or ones that are more profitable. Over time you will build your reputation and widen your network, however from the time you start it is important to build your brand and the way you want to be seen by potential clients.
Utilize different channels like attending networking events, online marketing, and joining relevant groups and associations. All these channels provide different ways for you to meet new customers and bid for new opportunities.
- Maintain your business
Aside from selecting the right business structure and marketing strategy it is important to maintain your operations properly. This can be done if you optimize your time properly, reduce your risk by getting a variety of different projects, and keeping in contact with your customers, both old and new.
Find out how other freelancers manage their workload and maintain their clients and learn from them. While their style may not be ideally what you want, it can improve the idea of how you want to run your business.
Independent contractors are becoming increasingly important for business and the number of contractors is undoubtedly growing. For both businesses and independent contractors this kind of relationship has a balance of pros and cons that should be considered before you decide to become a freelancer.
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