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Pros and Cons of the Independent Contractor's Life
This article explores what's good and bad about being an IC as compared with being an employee.
An independent contractor (IC) is a person who contracts to perform services for others without having the legal status of an employee. Most people who qualify as independent contractors follow their own trade, business or profession -- that is, they are in business for themselves. This is why they are called "independent" contractors. They earn their livelihoods from their own independent businesses instead of depending upon an employer to earn a living.
Good examples of ICs are professionals with their own practices such as doctors, lawyers, dentists and accountants. However, any person who is in business for himself or herself qualifies as an IC.
While independent contracting is common in highly specialized or technical fields such as computer programming, engineering or accounting, there is hardly any job that ICs don't perform -- from construction to marketing to nursing.
Some people seek to become ICs, others have the status thrust upon them. Whichever group you fall into, this article explores what's good and bad about being an IC as compared with being an employee.
Advantages of Working as an Independent Contactor
There are many rewards for being an independent contractor that regular wage earners may never benefit from.
You're your own boss
When you're an IC you're your own boss, with all the risks and rewards that entails. Most ICs bask in the freedom that comes from being in business for themselves. They would doubtless agree with the following sentiment expressed by one IC: "I can choose how, when and where to work, for as much or little time as I want. In short, I enjoy working for myself."
ICs are masters of their economic fate. The amount of money you make is directly related to the quantity and quality of their work. This is not necessarily the case for employees. ICs don't have to ask their bosses for a raise, they go out and find more work.
Moreover, since you're normally not dependent upon a single company for your livelihood, the hiring or firing decisions of any one company don't have the impact on you they have on employees. An IC explains: "I was downsized six years ago, and chose to start my own company, rather than sign on for another ride on someone else's roller coaster. It's scary at first, but I'm now no longer at the mercy of one entity."
You may earn more than employees
You can often earn more as an IC than as an employee in someone else's business. For example, an employee in a public relations firm decided to become an IC when she learned that the firm billed her time out to clients at $125 per hour while only paying her $17 per hour. She charges $75 per hour as an IC and makes a far better living than she ever did as an employee.
According to The Wall Street Journal, ICs are usually paid at least 20% to 40% more per hour than employees performing the same work. This is because hiring firms don't have to pay half of ICs' Social Security taxes, pay unemployment compensation taxes, provide workers' compensation coverage or employee benefits like health insurance and sick leave. Of course, how much you're paid is a matter for negotiation between you and your clients. ICs whose skills are in great demand may receive far more than employees doing similar work.
You'll probably pay fewer income taxes
Being an IC also provides you with many tax benefits that employees don't have. For example, no federal or state taxes are withheld from your paychecks as they must be for employees. Instead, ICs normally pay estimated taxes directly to the IRS four times a year. This means you can hold on to your hard-earned money longer without having to turn it over to the IRS. Moreover, it's up to you to decide how much estimated tax to pay, but there are penalties if you underpay. The lack of withholding and control over estimated tax payments can result in improved cash flow for ICs as compared with employees.
Even more important, you can take advantage of many business-related tax deductions
that are limited or not available at all for employees. When you're an IC, you can deduct from your income tax any necessary expenses related to your business so long as they are reasonable in amount and ordinarily incurred by businesses of your type. This may include, for example, office expenses including those for home offices, travel expenses, entertainment and meal expenses, equipment and insurance costs and more.
In contrast to the numerous deductions available to ICs, an employee's work-related deductions are severely limited. Some deductions available to ICs may not be taken by employees -- for example, the cost of commuting to and from work is not deductible by an employee but may ordinarily be deducted by an IC who has a main office separate from that of a client. Even those expenses that are deductible may only be deducted to the extent they exceed 2% of the employee's adjusted gross income. This means that most employment related expenses cannot be fully deducted.
ICs can also establish tax advantaged retirement plans such as SEP-IRAs and Keogh Plans. This enables them to shelter a substantial amount of their income until they retire.
Because of these tax benefits, ICs often pay less tax than employees who earn similar incomes.
Disadvantages of Working as an Independent Contactor
Despite the advantages, being an IC is no bed of roses. Following are some of the major drawbacks and pitfalls.
No job security
As discussed above, one of the best things about being an IC is that you're on your own. But this can be one of the worst things about it as well.
When you're an employee, you must be paid as long as you have your job, even if your employer's business is slow. This is not the case when you're an IC. If you don't have business, you don't make any money. As one IC says, "If I fail, I don't eat. I don't have the comfort of punching a time clock and knowing the check will be there on payday."
No employer-provided benefits
Although not required to by law, employers usually provide their employees with health insurance, paid vacations and paid sick leave. More generous employers may also provide retirement benefits, bonuses and even employee profit sharing.
When you're an IC, you get no such benefits. You must pay for your own health insurance, often at higher rates than employers are able to pay. Time lost due to vacations and illness comes directly out of your bottom line. And you must fund your own retirement.
If you don't earn enough money as an IC to purchase these items yourself, you will have to forgo some or all of them.
No unemployment insurance benefits
ICs also don't have the safety net provided by unemployment insurance. Hiring firms do not pay unemployment compensation taxes for ICs and ICs can't collect unemployment when their work for a client ends.
No employer-provided workers' compensation
Employers must generally provide workers' compensation coverage for their employees. Employees injured on the job are entitled to collect workers' compensation benefits even if the injury was their own fault.
Hiring firms do not provide workers' compensation coverage for ICs. If a work-related injury in an IC's fault, he or she has no recourse against the hiring firm.
Few or no labor law protections
A wide array of federal and state laws protect employees from unfair exploitation and discrimination by employers. Few or none of these laws apply to ICs.
Risk of not being paid
Employees normally have no problem being paid on time by their employers. This is not always the case when you're an IC. Some ICs have great difficulty getting their clients to pay them on time or at all. When you're an IC, you bear the risk of loss from deadbeat clients.
Liability for business debts
Finally, you are usually personally liable for your business debts. Employees are not liable for the debts incurred by their employers. An employee may lose his or her job when the employer's business fails, but will owe nothing to the employer's creditors. An IC whose business fails could lose most of what he or she owns.
Despite the drawbacks, more or more people are becoming ICs and the trend is expected to continue. Indeed, some experts predict that the number of ICs will double in 10 years.
Copyright 2002 Nolo, Inc.