What is an Independent Contractor? Definition, Pros & Cons, And More

Laws vary by jurisdiction, but in general a contractor must stay independent from the client's business. That usually means they:

• Control how, when, and where the work gets done, including their own hours and methods
• Cover their own tools, equipment, and business costs
• Work project to project, often for several clients at once
• Invoice for their work instead of receiving a paycheck, typically on a monthly or bi-weekly cycle

Independent Contractors vs. Employees 

To help you understand the crucial differences between independent contractors and employees, I’ve broken down each worker classification in more detail.

Independent Contractors

An independent contractor is a self-employed individual who provides services to clients while maintaining control over how these services are delivered. They are not salaried employees; instead, they are paid based on the terms of their written contract which often specify payment upon the completion of the job or upon reaching key project milestones.

They are also responsible for managing their own tax payments, which means they are not subject to withholding or payroll taxes. In addition, independent contractors must secure their own insurance coverage according to the regulations of their trade, such as general liability and errors & omissions insurance. Contractor payroll is usually a self-driven system of invoices and payments on a monthly or bi-weekly cycle.

Full-Time Employees

In contrast, employees work under an employer's direct supervision, adhering to set hours and using employer-provided tools. They are paid at a regular cadence according to their employment contract and are subject to payroll taxes and other withholdings according to the legal requirements of their jurisdiction.

As an employee, individuals are eligible for other benefits such as paid vacation time, paid sick leave, extended health insurance, disability & life insurance, and long-term retirement savings vehicles, such as a 401K or a Retirement Savings Plan (RSP). Employees are also covered by their company’s insurance coverages including general liability and errors & omissions insurance.

Key Comparison Table for Independent Contractors vs Employees

Here's how the two worker types compare:

	Independent contractor	Employee
Clients	Can work for several at once	Works for one employer
Length of relationship	Project-based, with a defined end	Ongoing, no set end date
Control	Decides how and when the work is done	Employer directs how, when, and where
Tools and equipment	Responsible for sourcing items, including the costs of repairs and maintenance, unless otherwise specified in a contract.1	The cost of all tools, equipment, and resources are covered by the employer.
Benefits	None; arranges their own	Group benefits such as health insurance, paid time off, and retirement plans
Pay and taxes	Invoices for payment and pays self-employment taxes	Paid wages or salary through payroll, with taxes withheld
US tax forms	Form W-9; Form 1099-NEC	Form W-4 and Form W-2; employer also files Form 941 or 944 and Form 940; Form I-9 (from USCIS) verifies work eligibility

The Internal Revenue Service (IRS) has also set guidelines to differentiate between independent contractors and employees. These are based on three categories: 

• behavioral control (who has the right to direct and control the work performed), 
• financial control (the business aspects of the worker's job), and 
• the relationship of the parties involved. 

These criteria serve as a legal framework, and if not properly classified, it could result in significant legal and financial implications for a business.

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Who Can Be an Independent Contractor?

Virtually anyone can become an independent contractor, provided they possess the skills and expertise desired by businesses.

Independent contractors span numerous industries - from freelance writers to graphic designers, software developers, electricians, consultants, and many other types of specialists. Essentially, if there is a professional service to be offered, there is a potential for independent contractor work.

However, being an independent contractor isn’t for everyone. To be successful requires not only expertise in a specific field but also enough business acumen to run your own business, including handling financials and maintaining client relationships. This requires a much different skill set than being an employee.

A person with an entrepreneurial spirit, the ability to work independently, and the willingness to absorb both the risks and rewards of business ownership is an ideal candidate for becoming an independent contractor.

Hiring an Independent Contractor

When engaging an independent contractor, it's crucial to evaluate their qualifications, professional background, references, and experience to ensure they're capable of performing the tasks. Thankfully, many freelance recruiting platforms pre-vet their talent, making this part of the process easier.

The contractor should have a Federal Taxpayer Identification Number and be responsible for their own business taxes. 

In the agreement, the tasks and services should be clearly outlined and both parties should be explicit about expected results, deadlines, compensation, and how to resolve any potential disputes. 

Also, ensure that the independent contractor complies with all relevant industry regulations, laws, and professional standards - including obtaining their own insurance. 

Author's Tip

Avoid exerting control over how the contractor performs their tasks, as this can blur the lines between a contractor and an employee, potentially complicating legal and tax details. Instead, focus on the outcomes and results.

Pros and Cons of Hiring an Independent Contractor

Hiring an independent contractor does offer several advantages to businesses that need to access specialized skill sets temporarily. However, the decision to work with an independent contractor needs to be considered carefully against some of the potential drawbacks. 

The Pros

Here are some of the advantages of working with an independent contractor:

• Reduced operational costs that are often required for full-time employees (e.g., workers’ compensation, health benefits, retirement contributions, and paid time off)
• Access to specialized skills without needing to invest in extensive training costs or resources
• Greater flexibility in work arrangements, including the ability to adjust the scope of the independent contractor’s involvement in tasks based on fluctuating project demands

The Cons

However, some downsides need to be considered when hiring independent contractors, including:

• Contractors may work with multiple clients simultaneously, slowing their output
• Potential issues with loyalty and company allegiance
• Potential problems with confidentiality and competition
• Lack of company control over contractors can also be challenging (limited control over output, expectations, or level of effort, etc.)
• Potential employee misclassification issues, leading to legal issues, unpaid taxes, and penalties

If you’re considering hiring an independent contractor, it's important to weigh the pros and cons carefully for your business and each specific project.

Being an Independent Contractor

If you have your heart set on becoming a non-employee, make sure to consider all the angles before you declare your new independent contractor status. To help you make that decision, I’ve summarized the key pros and cons of this worker classification below. 

Pros and Cons of Being an Independent Contractor

Being an independent contractor comes with several advantages as well as potential challenges. To give you a more informed perspective of what it’s like to be a sole proprietor, here’s a quick summary of the key pros and cons.

The Pros

Being a small business owner does offer many advantages that aren’t available to full-time employees, including:

• Flexibility in terms of work schedule, location, and assignments
• Full autonomy regarding who to work for, the type of work you want to do, and when you want to do it
• An increased sense of control over your career 
• The potential to earn more than your employed counterparts because you can negotiate your pay rates and work for multiple clients simultaneously
• The fringe benefit of potential tax deductions for business expenses

The Cons

Before you launch your small business of one, take some time to consider the potential challenges you may face along the way, so you can make an informed decision. These include:

• A lack of certain benefits such as health insurance, retirement plans, and paid vacations (this can be problematic in the event of a medical emergency or during retirement)
• Sole responsibility for managing your income tax requirements and social security tax contributions
• The common reality of working longer hours to meet client requirements, especially when working for multiple clients simultaneously
• No guaranteed job security since clients can decide to terminate contracts at any point
• Potential periods of no work, which can lead to financial instability
• A potential feeling of isolation and lack of camaraderie found in traditional workplace environments

Paying an Independent Contractor

Although payment methods might differ from contractor to contractor, the most common method is via invoicing. The contractor submits an invoice for their work to their client, which the company then pays within an agreed time frame. Make sure to have a written contract that clearly stipulates the payment terms, scope of the project, and other necessary details to ensure clarity and prevent disputes.

In addition, advanced payroll software or contractor management systems can help you streamline the payment process. These software solutions can help you to track and document payments, ensuring that all invoices match contract agreements, and all transactions are recorded and available for future reference. 

You'll also need to file Form 1099-NEC if you pay an independent contractor $2,000 or more in a year. That threshold applies to payments made in 2026 and later, up from $600 for payments through 2025, and it will be adjusted for inflation starting in 2027.

Employer of Record Service

An Employer of Record (EOR) service becomes the legal employer of a worker on your behalf. It handles payroll, taxes, benefits, and employment-law compliance, while you direct the day-to-day work. This is especially useful when you want to hire in a country where you have no legal entity: the EOR employs the person locally and provides their services to you.

Two things to keep in mind. First, an EOR employs the worker, so that person is an employee of the EOR, not an independent contractor. Many EORs also offer contractor management and classification reviews, so ask what's included. Second, an EOR shifts much of the compliance burden but doesn't remove all of your responsibility, so choose a provider that knows the laws in your location and industry. This is often a streamlined solution for businesses navigating complex international employment laws and taxation systems.

Global Payroll Service

If you’re planning to use independent contractors on a global scale, working with a global payroll service is also worth considering. Global payroll services ensure accurate, consistent, and compliant payments to contractors or employees across numerous countries. They also make reconciliation and reporting an easy task, offering an integrated view of all contractor payments. 

Many EOR providers actually offer global payroll services for a reduced fee, while still offering services to manage compliance and monitor for possible employee misclassification issues. 

Why is Worker Classification Important?

In the US, the IRS uses classification to determine payroll taxes, and the Department of Labor (DOL) uses it to apply federal wage and hour laws. Contractors aren't covered by the same tax withholding and legal protections as employees, so a misclassified worker can mean underpaid taxes, legal action, and penalties. It can also damage trust if employees feel contractors get preferential treatment.

Misclassification Risks

Treating an employee as a contractor can lead to:

• Fines and penalties from government agencies
• Unpaid payroll taxes you should have withheld and remitted
• Retroactive wage claims, including overtime
• Back payments for benefits such as health insurance, retirement contributions, and paid time off
• Related claims such as discrimination, wrongful termination, or retaliation

How Worker Status Is Tested

There's no single test. Which one applies depends on who is asking:

Test	Used by	What it looks at
Common-law test	IRS	Behavioral control (who directs the work), financial control (business expenses, investment, how the worker is paid), and the relationship of the parties (contracts, permanence)
Economic reality test	DOL (federal wage and hour law)	Whether the worker is economically dependent on the employer or in business for themselves, based on factors such as control over the work, opportunity for profit or loss, skill required, permanence, and whether the work is part of the employer's integrated operations
ABC test	Some states, such as California and New Jersey	Presumes the worker is an employee unless the company shows the worker is free from its control, does work outside its usual course of business, and is customarily engaged in an independent trade

IRS Classification Rules

The IRS has strict classification rules for determining whether an individual is an independent contractor or an employee. Their primary criteria revolve around the degree of control and independence in the relationship between the worker and the employer. 

The IRS looks at three categories: 

1. Behavioral control
2. Financial control, and 
3. The type of relationship of the parties involved.

Behavioral control refers to the level of instruction given to a worker, including when and where to work, what tools to use, or where to purchase supplies. 

Financial control considers the business aspects of the worker’s job, such as the extent to which the worker has unreimbursed business expenses, the level of investment in facilities used by the worker, and how the business pays the worker. 

With the relationship of the parties, the IRS assesses factors such as written contracts and the permanency of the relationship. 

It's crucial to get this classification right as it affects tax obligations, benefits, labor law rights, and more.

DOL Status Test

The Department of Labor (DOL) uses a specific status test to determine whether an individual is categorized as an independent contractor. The test, also known as the "economic realities" test, considers the degree of the worker’s economic dependency on the employer. Its main focus is not on the level of control an employer has over a worker, but rather, if the worker is economically dependent on the employer.

Key factors in the DOL status test include: 

• the nature and degree of the worker's control over the work,
• the worker's opportunity for profit or loss, 
• the amount of skill required for the work, 
• the permanency of the working relationship, and 
• the degree to which the work is part of an integrated unit of production. 

The evaluation of these factors is carried out on a case-by-case basis, ensuring a thorough examination of each individual's work scenario. The intent behind this meticulous analysis is to prevent misclassification and preserve the rights of workers.

Frequently Asked Questions

Here are some answers to popular questions we’ve received about independent contractors:

Are independent contractors defined differently in other countries?

Yes. This article covers US rules (IRS and DOL). Elsewhere, the Canada Revenue Agency weighs factors such as control, tools, and financial risk. Many European countries target “false self-employment,” where workers are labeled contractors to avoid benefits and taxes. The UK has a “worker” category between employee and contractor that carries some employment rights. If you hire internationally, review each country’s criteria or use an EOR.

Can an independent contractor become an employee later?

Yes, if both sides agree and the arrangement changes to match. Businesses might pursue this transition if they find the contractor’s role has evolved into one that resembles a regular employee position over time or if they want to secure the contractor’s skills exclusively. However, this change isn’t always simple and often requires careful handling to ensure compliance with labor laws.

That means adding payroll, tax withholding, and benefits, plus the supervision, schedule, and terms that come with employment. Document the transition clearly so the new arrangement holds up under classification tests, and check the tax, insurance, and benefit implications first.

What is the voluntary classification settlement program?

The Voluntary Classification Settlement Program (VCSP) is an IRS program that lets eligible employers reclassify contractors as employees going forward, with limited liability for past misclassification. To qualify, you must have consistently treated the workers as contractors, filed all required 1099s for them for the previous three years, and not be under audit by the IRS, DOL, or a state agency over their classification.

Instead of full back taxes, interest, and penalties, you pay 10% of the employment tax that would have been due on the workers’ pay for the most recent tax year, calculated at reduced rates under Section 3509(a) of the tax code. You apply using IRS Form 8952.

Are there retirement and insurance options for independent contractors?

Yes, but contractors set them up on their own. For retirement, popular US options include a SEP IRA, Solo 401(k), and SIMPLE IRA. For insurance, contractors can buy health coverage through government marketplaces or industry associations, and many add disability and professional liability coverage. Contractors choose and fund these themselves, which means they can tailor coverage to their needs.

Reduce Employment Risks with an EOR

If you're ready to hire workers abroad or want help staying compliant, partner with an EOR that knows your industry and region. This can help to further safeguard against potential issues, meeting your team's specific needs, while also reducing administrative hassles.

However, it is just as important to choose the right employer of record service. One that is competent, trustworthy, and familiar with the laws and regulations of your specific field and area to minimize any potential risks of using an EOR service.

Country-Specific EOR Services

Do you have your heart set on sourcing new talent in a specific country? We’ve compiled our thorough research into the best EOR providers in the following countries, to speed up your partnership process considerably.

• Australia's best EOR services
• Brazil's best EOR services
• Canada's best EOR services
• Chile's best EOR services
• China's best EOR services
• Colombia's best EOR services
• France's best EOR services
• Germany's best EOR services
• Hong Kong's best EOR services
• India's best EOR services
• Indonesia's best EOR services
• Italy's best EOR services
• Japan's best EOR services
• Netherland's best EOR services
• Philippines' best EOR services
• Portugal's best EOR services
• Singapore's best EOR services
• Spain's best EOR services