Sole Proprietor vs. Independent Contractor: The Differences and Similarities

Is a sole proprietor the same as an independent contractor?

If you don’t know how to classify the people you hire when you’re building a team for your small business, it could result in a variety of problems from a tax and labor law perspective. For instance, you must withhold taxes from full-time employees’ paychecks; independent contractors, who handle their own tax payments, are typically exempt from this requirement. Independent contractors are not entitled to overtime pay under the Fair Labor Standards Act (FLSA), even if you have non-exempt employees on your payroll.

Sole Proprietor Taxes vs Independent Contractors Ep 3.

What is an independent contractor?

While not employees, independent contractors are also self-employed people who offer services to clients and businesses. Depending on the work they perform, independent contractors are paid. Depending on the terms of their contract, they might be paid by the hour or per project. Unless the contractors are subject to backup withholding, businesses that employ independent contractors do not deduct payroll taxes from their pay. In the creative and technical industries like web development, content creation, graphic design, or IT, independent contractors are common.

The term “independent contractor” can also refer to a person who receives a 1099 tax form at the end of the year. A 1099-MISC form, which details the total income received for the calendar year, will be provided to contractors who receive at least $600 from a client or business. Individuals working as independent contractors for various clients would get various 1099-MISC forms. The contractors tax return would include all of the income reported on each form, and those forms would also be used to deduct all necessary self-employment taxes.

The 1099-NEC form was introduced by the IRS in place of the 1099-MISC form for the 2020 tax year. In the future, this form will be used to report non-employee compensation. In order to give independent contractors enough time to prepare and file their taxes, businesses and clients who hire them must send these forms by January 31.

What is a sole proprietor?

A sole proprietor is a person who runs a business by themselves. An unincorporated business structure known as a sole proprietorship is managed by one person. You are personally responsible for all business debts and legal obligations if you run a sole proprietorship. Each year, you file the IRS Form 1040 Schedule C to detail your business income and expenses, but you pay taxes on your business income on your personal tax return. Anyone who anticipates paying at least $1,000 in income tax is required to submit estimated taxes.

The fact that a sole proprietor runs their own business makes them self-employed. When you work for yourself, you don’t have a regular employer who pays a salary or wage; instead, you contract with and provide goods or services to a variety of clients to generate income. Additionally, sole proprietors must cover their own self-employment taxes, including Social Security and Medicare taxes. Self-employment tax is approximately 15. 3% of your net income.

A sole proprietorship is the typical business structure for small businesses. To operate as a sole proprietorship, you are not required to register your business with the state or federal government, get a business license, or reserve your business name. You have effectively created a sole proprietorship when you start a business and separate your personal finances from your business finances; you are now regarded as a sole proprietor.

Sole proprietor vs. independent contractor

Independent contractors and sole proprietors are both types of non-employee self-employed people. Instead, they work independently and do not have a set wage for the services or products they provide to clients. The two categories resemble each other in that those in both roles:

The manner in which compensation is reported is the primary distinction between a sole proprietor and an independent contractor. While an independent contractor will receive a 1099 form outlining the income earned during the previous calendar year, a sole proprietor is responsible for keeping track of all business expenses. A sole proprietor, however, might get a 1099 form from their customer, depending on the kind of services offered.

FAQs about sole proprietors and independent contractors

You might have concerns about the setup or how to handle particular circumstances as they come up when you start your own business or offer services on a contract basis. Since neither independent contractors nor sole proprietors have a human resources department or supervisor to turn to for help, they are both responsible for handling their own tax obligations, keeping track of their expenses, and dealing with any issues that arise. Become familiar with some of the frequently asked questions about sole proprietors, independent contractors, and self-employment.

Can I be a self-employed sole proprietor?

Because they do not have an employer or perform work as an employee, a sole proprietor is, in fact, self-employed. You are considered a self-employed business owner if you own and run your own company.

Is an independent contractor a sole proprietor?

Depending on the type of work they perform and how they are compensated, an independent contractor may be a sole proprietor. Some independent contractors perform freelance work while simultaneously serving multiple clients. Others work full- or part-time jobs as employees in addition to offering independent contracting services. If this describes you, you can refer to yourself as a sole proprietor since you are the only person running the business.

How is a sole proprietorship different from other business structures?

The simplest and least expensive business structure to establish is a sole proprietorship because you do not need to take any steps to register it with the government or IRS. It also doesn’t run independently from you, the business’s owner, so you are personally liable for any debts or obligations the company incurs under the law. Other business structures include:

Do I have to register my sole proprietorship as a legal entity?

Generally speaking, sole proprietorships are exempt from registration requirements for legal business entities. Unless you sell goods or services that need a license, you are not required to apply for a business license or register the business name with your local government body. For instance, medical professionals who work as independent contractors are required to hold a license.

To prevent another sole proprietor or business owner from opening a business with the same name, some sole proprietors opt to take these precautions. Making your business appear more credible to lenders and investors may be accomplished by registering it, obtaining a license, and opening a business bank account.

Should I use a written agreement as an independent contractor?

Independent contractors are advised to enter into written agreements with their clients that detail the services to be provided, your fee, and the timeline for the services. Written independent contractor agreements can also clarify that you are working with a hiring firm rather than an employer.

FAQ

Do sole proprietors need a 1099?

Unless they employ independent contractors or subcontractors, sole proprietors are not required to complete Form 1099. They use this form to report their earnings if they work alone.

How do I know if I am a sole proprietor?

A person who runs an unincorporated business alone is known as a sole proprietor. However, if you choose to treat a domestic limited liability company (LLC) as a corporation and you are the only member, you are not a sole proprietor.

What is the difference between a self-employed and independent contractor?

One of the many ways to qualify as self-employed is by working as a freelancer. By definition, self-employment is the act of making money without engaging in an employee-employer relationship, as opposed to independent contracting, which is the provision of work or services on a contractual basis.

Is being an independent contractor the same as owning a business?

Both independent contractors and sole proprietors are self-employed business owners. They both maintain records of their business’s earnings and expenditures, use Schedule C to file their income taxes (unless a different business type is selected), and pay self-employment taxes on that income.

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