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

With the growth of the gig economy in recent years and the prevalence of hiring remote workers, distinguishing between contractors and employees has never been more important.

This article will clarify the difference between independent contractors and employees, outline the pros and cons of hiring or being an independent contractor, and explain the ins and outs of employee misclassification.

I’ll also explain how an Employer of Record (EOR) can reduce the challenges of working with independent contractors and ensure your business remains compliant with labor and tax laws. For example, Globalization Partners EOR solutions help businesses manage the challenges of hiring independent contractors internationally.

Using independent contractors can be a strategic move, but it requires a thorough understanding and careful management.

What is an Independent Contractor?

An independent contractor, otherwise known as a freelancer or consultant, is a self-employed individual who offers specified services to clients under terms that are negotiated and defined in a contract. These individuals are responsible for paying their own taxes, arranging their own benefits, and acquiring necessary insurance. 

Different jurisdictions have their own unique laws governing independent contracting, but in general, an independent contractor must maintain independence from the client's business.

They must exhibit a substantial degree of control over their work, including the ability to set their own hours, define the scope of their work, and decide on the process and methods of completion. They also must bear any financial responsibilities required to fulfill their contract, including the cost of any tools or resources they need to access. 

Independent contractors typically work on a project-to-project basis, and they can offer their services to multiple clients simultaneously. Lastly, contractors typically invoice for services rendered and do not receive a traditional paycheck like employees. Rather, contractor payroll is usually a self-driven system of invoices and payments 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.

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

Worker’s Status	Independent Contractor	Employee
Working Relationship	May work for multiple clients or companies simultaneously.	Works for one client or company.
Length of Relationship	Contractual for a specific task or short-term period. Often project-based.	Ongoing employment relationship with no specified end date.
Degree of Control	Client has limited control over how and when the individual completes their work.	Work is completed according to the employer’s requirements, including when and how the work is completed.
Resources, 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.
Employee Benefits	Not eligible for group benefits. They must seek personal plans instead.	Often entitled to comprehensive employee benefits through group plans, including health and dental insurance, disability and life insurance, pension plans, etc.
Payments & Taxes	Paid irregularly according to their contract agreement. Contractors submit invoices for payment and pay self-employment taxes.	Paid a regular hourly wage or salary via payroll, including typical employment taxes and payroll deductions.
Required Tax Forms (USA only)	IRS Tax Form W-9 IRS Tax Form 1099-NEC IRS Tax Form 1096	IRS Fax Form I-9 IRS Tax Form W-4 IRS Tax Form 941 or Form 944 IRS Form 940 IRS Form W-2

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 IRS Form 1099-NEC if you pay an independent contractor $600 or more during the year. This form reports the income to the IRS and the contractor, ensuring you stay compliant with tax regulations.

Employer of Record Service

An Employer of Record (EOR) service is an alternative option to consider for companies planning to partner with independent contractors. An EOR essentially takes on the legal and administrative responsibilities of being an employer, including HR, payroll, tax, employee benefits and liability coverage. As part of this process, they also use a robust worker classification process to verify the independent contractor relationship and eliminate the possibility of employee misclassification errors. 

Working with an EOR enables businesses to sidestep the intricacies of employment law and regulations, simplifying the process of engaging with independent contractors. This option offers the most peace of mind for HR and payroll administrators, as it lifts the burden of liability and compliance off of your company, and into the realm of the EOR provider. 

An EOR can also assist companies by managing contractors in geographical areas where the client company has no established entity. The Employer of Record acts as a local entity, hiring the contractor on behalf of the company and subsequently leasing their services back to the company. This allows businesses to bypass complex international employment laws and taxation systems, hence providing a streamlined and efficient solution. 

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 Employee Classification Important?

The importance of correct worker classification stems from its financial, legal, and administrative implications. For instance, in the US the IRS uses employee classification to determine payroll taxes, while the Department of Labor refers to it when applying federal labor and wage laws.

Independent contractors aren’t subject to the same tax deductions and legal protections as traditional employees, so employee misclassification can lead to underpaid taxes, legal actions, and penalties.

In addition, employee misclassification can impact workplace dynamics and affect the employer-employee relationship. As an employer, you might accidentally erode trust and mismanage resources if, for instance, full-time employees perceive independent contractors as receiving preferential treatment. 

Correct worker classification ensures transparency, compliance, and fairness in a company's operational functionality, while avoiding labor disputes, tax complications, and potential litigation. It helps to create a harmonious workplace environment, ensuring that everyone’s rights and responsibilities are treated equally and fairly.

Misclassification Risks

Misclassifying an employee as an independent contractor can lead to significant legal issues and financial consequences for an organization. This is mainly because the statutory rights and benefits accorded to an employee significantly differ from those of independent contractors. 

The most common risks involve tax liabilities, where the employer should have been withholding and remitting taxes but failed to do so. Organizations may also face retroactive wage claims, employee benefits disputes, and fines or penalties from government agencies. 

Additionally, misclassification can result in back payments for benefits like health insurance, retirement contributions, or paid time off that the independent contractor would have received as an employee. 

There is also the risk of exposure to related claims, like discrimination, wrongful termination, or retaliation claims. If a company is not careful with its worker classification process, it could potentially face unexpected and avoidable financial liabilities. That’s why it’s essential for an organization to understand the legal definitions and differences between an employee and an independent contractor.

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, each country has a unique definition and process of identifying an independent contractor from an employee. This article is focused on the definition of an independent contractor in the United States, using IRS and Department of Labor criteria.

In Canada, the Canada Revenue Agency uses a similar but distinct set of criteria, focusing on the degree of control and ownership of tools. Meanwhile, European countries often apply more stringent regulations to prevent “false self-employment,” where workers may be misclassified to avoid benefits and tax obligations.

In many cases, countries establish legal tests or frameworks to assess whether a worker is genuinely independent, with criteria tailored to local labor laws and social security requirements. For instance, the UK has a “worker” category that sits between an employee and an independent contractor, granting some employment rights without full employee benefits.

Due to these differences, businesses hiring international contractors must carefully review and adhere to each country’s specific criteria to avoid misclassification risks and ensure compliance, or outsource these responsibilities to a third-party Employer of Record service.

Can an independent contractor become an employee later?

Yes, an independent contractor can transition to an employee if both the contractor and the hiring organization agree to the change and modify their working arrangement accordingly. This shift typically involves adjusting the contractor’s responsibilities, terms of engagement, and employment status to meet employee standards, which may include offering benefits, adhering to a set work schedule, and establishing a more direct oversight relationship.

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.

Remember that converting a contractor to an employee has tax, insurance, and benefit implications. It’s important to document the transition clearly and align the role with employment standards to avoid issues with worker misclassification and potential penalties.

What is the voluntary classification settlement program?

The Voluntary Classification Settlement Program (VCSP) is an IRS initiative in the United States that allows employers to reclassify workers as employees instead of independent contractors while minimizing their tax liability for previous misclassification.

Through the VCSP, companies can voluntarily correct worker classification issues and pay reduced penalties instead of facing full audits, back taxes, and other penalties if misclassification is discovered later. This program is especially helpful for businesses looking to rectify unintentional misclassification in a proactive, cooperative way with the IRS.

To participate in the VCSP, employers must meet specific eligibility criteria, such as having consistently classified the workers in question as contractors and not currently being under IRS or Department of Labor audit for worker classification.

If accepted, the employer pays a reduced employment tax amount—generally about 10% of what would have been owed—and avoids interest, penalties, and the risk of further classification audits.

The VCSP offers businesses a more manageable route to compliance, allowing them to address potential issues before they escalate into costly legal challenges.

Could hiring independent contractors impact company culture?

Yes, hiring independent contractors can influence company culture in both positive and challenging ways. Independent contractors bring fresh perspectives, specialized expertise, and flexibility, which can inspire innovation and efficiency within teams. Their external experience can be a valuable asset, fostering creativity and helping employees view projects from new angles. For companies embracing a project-based or flexible workforce, contractors can align well with a culture that values agility, adaptability, and diverse skill sets.

However, integrating contractors can also pose challenges to a cohesive culture. Since contractors often work remotely or for shorter periods, they may not be as deeply immersed in the company’s values or day-to-day dynamics. This can lead to feelings of disconnect or misunderstandings among full-time employees and contractors. Companies can counteract this by creating inclusive onboarding practices, clear communication channels, and collaborative processes that help contractors feel like valued contributors to the team’s success, even if they aren’t full-time staff.

Are there retirement and insurance options for independent contractors?

Yes, independent contractors have access to various retirement and insurance options, though they typically need to set these up independently, as they are not provided by the hiring company.

For retirement savings for US independent contractors, individuals can choose from several tax-advantaged plans designed for self-employed individuals, such as a Simplified Employee Pension (SEP) IRA, Solo 401(k), or a SIMPLE IRA. These options allow contractors to contribute pre-tax income toward retirement, with contribution limits often higher than traditional employee 401(k) plans, making them a viable path for building long-term savings.

Insurance, including health, disability, and liability coverage, is also available to contractors, although it requires personal research and budgeting. Many contractors purchase health insurance through government marketplaces or join industry-specific associations that offer group health plans. Some also invest in professional liability insurance to protect against potential business risks.

While independent contractors bear full responsibility for selecting and funding these benefits, the flexibility allows them to tailor coverage to their specific needs and professional goals.

Use an Employer of Record Service to Reduce Employment Risks

If you’re ready to venture down the road into the world of hiring independent contractors, I recommend partnering with an Employer of Record (EOR) service to guide you through this uncharted territory. 

An EOR partner will help you mitigate the risks associated with hiring an independent contractor, and alleviate the potential concern of misclassification. This not only offers your organization peace of mind, but it also serves to reduce liability for issues like tax compliance, and labor laws.

However, it is essential to choose an employer of record service 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. This can help to further safeguard against potential issues, while also reducing administrative hassles and freeing up your internal resources for more strategic tasks.

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
• China's best EOR services
• Colombia's best EOR services
• France's best EOR services
• Germany's best EOR services
• India'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
• Turkey's best EOR services
• UAE's best EOR services
• United Kingdom's best EOR services

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