Most labor regulatory bodies classify self-employed workers as either independent contractors or sole proprietors. In some situations, a worker may occupy both positions simultaneously. In general, however, the way independent contractors construct their businesses and generate money distinguishes them from sole proprietors.
Knowing what type of workers you are employing is essential to stay compliant with regulations and policies. Some details may vary from country to country. However, this article clarifies the critical contrasts between the two terms and how you can stay safe as an employer.
What Distinguishes an Independent Contractor from a Sole Proprietor?
Independent contractors and sole proprietors are self-employed individuals without established official business entities. They must file business taxes and pay self-employment taxes.
It is important to note that independent contractors are more common around the world. Sole proprietors may exist under different titles or sets of regulations in different countries.
The most significant distinction between both definitions is in how they make a living:
- Independent contractors perform particular functions for customers for fixed payments
- Sole proprietors often do contract work for a variety of sources. They may also receive income in other ways, such as by selling their own products
An independent contractor works for one or more companies on a contract basis. The employer has authority over what they do, but never over how and when they perform their tasks.
For instance, it is common for independent contractors to be freelancers, such as IT experts, graphic designers, and web developers.
Organizations employing independent contractors are not required to deduct income taxes, social security, or health insurance. However, companies in the US have to fill out form W-9. Independent contractors generally make additional monthly payments to third parties to finance income and self-employment taxes.
A sole proprietor is a one-person firm that has not been identified as a business entity by the government. You are a sole proprietor if you make a living from your corporation.
They are, in a way, independent contractors with more responsibility in terms of tracking expenses, income, and outgoings. It’s up to the sole proprietor to ensure they have everything from a good vision statement to control of their personal finances.
When you start a sole proprietorship, government tax organizations recognize any profit as personal income. You are directly liable for any profits or losses incurred by the company. In the US, this means filling in the correct information for form 1040.
The Similarities Between Independent Contractors and Sole Proprietors
Both independent contractors and sole proprietors are self-employed operators who are not considered employees. Instead, they provide customers with products or services but are not paid a standard wage.
Other parallels between both include:
- They do not work for any one organization but rather for themselves.
- Both distinguish their personal and business costs separately.
- They must pay self-employment taxation on business income.
The Risks and Benefits of Being a Sole Proprietor
A sole proprietor is responsible for everything related to their business revenue.
Some of the benefits of operating in this line of employment are:
- The possibility exists to start a business quickly after having an idea. There is no requirement for business registration and other lengthy paperwork.
- The responsibility for all business elements lies entirely on a sole proprietor to successfully carry out the business vision.
- Sole proprietors can recruit labor to work and grow their businesses at their own pace.
- A straightforward taxation process exists in many countries, allowing sole proprietors to file personal and business tax records simultaneously.
However, carrying the weight of such heavy responsibilities can also have drawbacks, some of which are as follows:
- A sole proprietor bears full responsibility for debts or losses, as well as transactions made while facing workers’ obligations.
- Banks may be reluctant to grant a sole proprietorship a loan because it is inherently volatile. Many sole proprietors must either provide initial investment or seek third-party funding to begin.
- It is common for sole proprietors to find themselves working beyond regular hours while running a business.
The Risks and Benefits of Being an Independent Contractor
An independent contractor has complete control over the performance of the job.
Among the advantages of this position are:
- An independent contractor has the luxury of greater flexibility regarding their schedule.
- Working for a company may result in a lower hourly pay rate than operating as an independent contractor.
- Because you will not be paying income taxes immediately, you will have the opportunity to earn more throughout the year.
There are unique challenges, such as less security, while working independently. Other common issues may include:
- It is challenging to generate the same monthly revenue without a guaranteed clientele. An independent contractor is in charge of growing every aspect of their business.
- The usual benefits provided by an employer, such as health insurance or workers compensation, are benefits independent contractors have to secure for themselves.
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Should I request a formal work agreement as an independent contractor?
Independent contractors should use legal contracts with their customers that outline the services delivered, the fee, and the timescale. When a company hires an independent contractor, they may still have to complete certain administrative steps, and a written contract can help.
An independent contractor document can also help to define your partnership in terms of tax or regulatory paperwork.
When should a business entity be formed?
The more successful your firm grows, the more vital it is to establish an official business structure like a limited liability company. The following are points to consider when it is time to create an entity:
- When it becomes critical to keep personal and business assets separate.
- When obtaining additional financing becomes too complex without a set structure.
Can sole proprietors and independent contractors become full-time employees?
It is possible to transition a contractor into an organization as a full-time employee, however many countries have strict requirements for this according to their Department of Labor. See our article on the subject here.
Can Sole Proprietors be Regarded as Independent Contractors?
Depending on the services provided, independent contractors can be sole proprietors and vice versa.
A sole proprietor outlines how someone pays taxes, while an independent contractor explains how someone makes a profit. The exact way these types relate to each other sis key when expanding to a new market.
Is an Independent Contractor the Same as Self-Employed?
Independent contractors are self-employed people delivering services to other people and enterprises.
Companies compensate independent contractor for the work that they complete. Under the conditions of the agreement, companies can pay them hourly or per project, which classifies them as self-employed.