Independent Contractor vs. Employee: How Their Taxes Differ

Whether you’re working for yourself full-time or just picking up a temporary job for extra cash, you’re likely classified as an independent contractor.

Working for yourself can offer flexibility and other advantages, but these perks come with trade-offs, especially when it comes to taxes.

Independent contractor vs. employee: What’s the difference?

Although you might do essentially the same work, the IRS views contractors and employees differently — and that means their tax situations are different, too.

Determining whether a worker is an employee or an independent contractor is based primarily on the degree of control and independence they have over their work.

• An employee typically completes tasks set by an employer and often receives training and equipment to do so. Employees usually work for a single employer who controls their schedule. In exchange, employees generally receive benefits on top of their wages, including health insurance, paid time off and retirement plan contributions.

• An independent contractor, on the other hand, usually works with multiple clients simultaneously, sets their own hours and determines how the work is completed using their own skills, tools and expertise. Contractors are responsible for invoicing for completed work and handling their own tax liabilities, insurance plans and other business expenses.

The distinction seems pretty clear-cut, right? It can be.

But it also offers businesses a gray area in terms of how to classify workers. And some companies use that wiggle room to hire contractors instead of employees, in large part to save on labor costs. There’s no need to pay benefits to contractors, and companies can save on taxes because it’s not necessary to pay the employer portion of Social Security and Medicare or state unemployment taxes. That burden falls on the independent contractor (more on this below).

In most cases, companies follow the law. But it can be a hassle to make someone an employee, which is why some businesses might be tempted to go the contractor route even when the job should be classified as an employee position.

Taxes for employees vs. independent contractors

Independent contractors may enjoy more autonomy in their work than traditional employees, but that freedom comes at a cost. While employees get help from their employers in managing their taxes, contractors are basically on their own. Let’s break it down.

Employee taxes

If you’re an employee, your boss pays half of your Social Security and Medicare taxes — together, usually referred to as FICA taxes.

In other words, you and your employer split your FICA tax liability, with each of you paying 6.2 percent for Social Security and 1.45 percent for Medicare. Employers also take care of paying your federal and state income taxes, based on your income tax bracket and how you’ve filled out your W-4 form.

That is, your employer withholds your half of FICA taxes and your income taxes from each of your paychecks, and sends that money to the IRS on your behalf.

After the year ends, the employer sends you a W-2 tax form that summarizes your earnings and deductions so you can file your taxes.

Contractor taxes

As an independent contractor, you get your full payment upfront — no deductions, no withholding. But don’t mistake that for a tax break. The autonomy that contractors enjoy also means taking on the full weight of their tax liabilities without assistance from an employer.

Since contractors don’t have taxes withheld from each payment, the IRS expects them to make estimated payments four times a year to stay on top of their tax obligations. While it’s technically possible to wait until tax season to settle your tax bill, you may face penalties and interest for underpaying taxes throughout the year. (The U.S. tax system is pay-as-you-go, meaning your taxes are owed throughout the year as you earn income.)

Another major difference between employees and contractors is that contractors must pay both halves of their FICA taxes. As noted, employees split FICA taxes with their employers. But independent contractors must pay the entire 15.3 percent themselves (12.4 percent for Social Security and 2.9 percent for Medicare).

All income is taxable

Keep in mind, too, that independent contractors are supposed to report their income — it doesn’t matter whether you’re paid in cash, check, digital transfer or barter. It’s taxable income, regardless of the payment method or amount.

Plus, the IRS rules for how and when earnings must be reported can cause confusion for independent contractors. When you’re a contractor, instead of a W-2 you get a separate Form 1099 from each client, detailing what you made (generally, it’s a 1099-NEC for non-employee compensation). The IRS gets copies, too.

But a client doesn’t have to send you a 1099 if you made less than $600 during the tax year.

That, however, is just a reporting requirement. It has no effect on your taxable income. Any amount you earn is legally taxable and you should report it, either on Schedule C or as other income on Form 1040.

Then there is the self-employment tax — that is, the FICA taxes — that you are responsible for in full. This amount is reported and paid via Schedule SE. But you don’t owe SE taxes unless you netted more than $400 from all contracting jobs in a tax year.

Why businesses choose contractors vs. employees

Being a contractor potentially could be beneficial for you from an earnings standpoint. But it’s generally not your decision to make when you’re looking for a job. The business gets to decide whether to post a job opening as a position for an independent contractor or an employee.

The length of time you work — for example, a few months over the holidays — doesn’t matter. Neither does whether you’re a part-time or full-time worker. Again, it goes back to the degree of control over the work done.

And if the company improperly hires you as a contractor, it’s the business that bears any compliance burdens and potential punishments. The IRS can come after the company when it discovers the misclassification and collect unpaid employment taxes.

Companies cite three main advantages for hiring independent contractors over full-time employees, according to a survey conducted in 2024 by Worldwide Business Research for WorkMarket/ADP:

• Access to specialized skills: Hire for niche expertise and project-based work
• A more flexible workforce: Scale up or down as needed
• Lower costs: Avoid paying health insurance, PTO, retirement contributions and other benefits

Among the companies surveyed, 86 percent plan to increase their use of independent contractors in the next year for these reasons.

Types of contract work

According to the U.S. Bureau of Labor Statistics (BLS), 11.9 million people were independent contractors as their sole or main job as of July 2023, representing 7.4 percent of the total U.S. workforce.

However, the contractor vs. employee decision isn’t necessarily a one-or-the-other choice. As long as you have the time, skills and resources, you could have a traditional job while also being an independent contractor.

Here are some examples of contract work that could either be your primary source of income or a supplement to your 9-5 job:

• Creative and digital services: Writers, graphic designers, social media managers
• Content and influencing: Podcasters, bloggers, streamers
• Consulting and professional services: Business consultants, legal consultants, financial advisors
• Skilled trades and technical services: Electricians, plumbers, auto mechanics
• Health care and wellness: Freelance nurses, personal trainers, massage therapists
• Education and coaching: Tutors, career coaches, corporate trainers
• Transportation and delivery services: Rideshare drivers, delivery drivers, freight drivers
• Real estate and property services: Real estate agents, property managers, landscapers
• Entertainment and events: Musicians, event planners, caterers
• Retail and e-commerce: Etsy sellers, Amazon FBA sellers, dropshipping owners
• Research and data services: Market researchers, data entry, transcriptionists

Alternatively, an independent contractor may be someone who takes on temporary work, which the BLS calls contingent work. These opportunities typically arise when businesses need additional employees to handle a surge in demand, such as retailers during Black Friday.