Independent contractor vs. Sole proprietor: do they mean the same thing? Find out!
The terms sole proprietor and independent contractor are often used interchangeably because they depict self-employment and share similarities. However, despite their similarities, these concepts are quite distinct. The sole proprietor vs. independent contractor narrative differs in business model, operations, and accruable tax.
As an independent professional or an entrepreneur, it is important that you recognize the distinction between the two occupational classifications, what they mean, and what legal rights accrue.
This guide will unveil the parallels and distinctions between both concepts.
Who is a sole proprietor?
Sole proprietors, also known as individual entrepreneurs, own and conduct a business without incorporating it as an autonomous legal body, such as an enterprise, company, or partnership. This means that the individual entrepreneur runs a business independently without registering it and is completely in charge of the business, including its liabilities and gains. There is simply no legal distinction between the owner and the business.
As a result, individual entrepreneurs are solely responsible for their business's costs and losses. Furthermore, they enjoy the exclusivity of all gains made.
Does a sole proprietorship business pay tax?
A sole proprietor is not distinct from his business because the business is not registered with the authorities. However, the sole proprietor is an individual who earns some profit from his business dealings and, as such, is obligated to pay income tax.
You must fill IRS 1040 Schedule C requirements in the US to disclose your business revenue and costs. This enables you to determine all taxes that accrue to you reliably.
Pros of sole proprietor
The sole proprietorship is one of the simplest business categories. It doesn't necessitate proper setup or registration; if you have a business idea, just start immediately. Here are some benefits of a sole proprietorship
It is easy and inexpensive: You may avoid many startup costs with an individual entrepreneurship business, such as incorporation fees, business name registration fees, other types of registration fees, etc. However, you may need a license or permit if your business niche requires one. Notwithstanding, the startup cost for a sole proprietorship is low.
Absolute ownership: The sole proprietor has absolute control and ownership of the business without any interference. The sole proprietor Is also entitled to all earnings.
Less cumbersome tax obligation: A sole proprietor is taxed at the regular income tax rate. That is, you are expected to disclose your gains and losses. The business is not taxed separately.
No required operational structure: A sole proprietor decides how he intends to run his business. There are no legal obligations for a board of directors, board of trustees, annual meetings, etc. The exclusion of these requirements makes it easier and less expensive to run.
Cons of sole proprietor
Sole proprietors bear all risk: Because sole proprietors are not obligated to register the business as a distinct legal entity, they bear every risk, loss, or liabilities the business incurs.
Difficulty in accessing credit facilities: Banks and finance houses are always reluctant to grant loans to sole proprietorship businesses. This is because the business is not a legal entity; any loan granted would be in the proprietor's name and not the business. In essence, the bank or creditor cannot sue the business in case of default.
There is often no business continuity: Usually, the demise of a sole proprietor also marks the end of the business except in rare cases.
Who is an independent contractor?
An independent contractor is a self-employed individual or professional who offers services to others or companies. Independent contractors are usually not full-time employees of any business or company; rather, they work based on contracts for a long time.
For instance, a graphic designer contracted to design a business card, letterheads, and logo for a new company is an independent contractor. Professionals like freelance tutors, interior designers, etc., are classified as independent contractors.
Independent contractors get compensated based on the amount of work completed per hour or for every job. They are not eligible for any form of employment benefits (such as insurance schemes) because they are self-employed. They are also responsible for paying their taxes when due.
Do independent contractors pay tax?
Yes, they do!
However, independent contractors are exempted from salary tax deductions because they are not employees. But they are liable for self-employment and income taxes.
Contractors pay their taxes by collecting a 1099-NEC form from clients who paid more than $600 during the taxable year. The document is sent to the IRS on or before the end of January. They are also required to file Form 1040 for self-employment taxes.
Pros of independent contractor
Independent contractors are self-employed workers; hence they enjoy the benefits of working for themselves. Here are some specific benefits you should know.
Enjoy working flexibility: They are not bound by fixed working hours or schedules. You decide when, where and whom you want to work with.
High probability of lower taxes: Independent contractors have some advantages regarding taxes. For instance, you are not required to pay tax on every paycheck. IC does not also pay federal and state taxes. Taxes are based on estimates and not actual figures because contractors' earnings are not readily verifiable.
You could earn more: Independent contractors can take on as much work as they can handle at any given time. They can also execute numerous jobs in a short period, allowing them to make more money than a typical employee.
Cons of independent contractor
There is no certainty of work: Working as a contractor isn't always easy. If you mostly work on temporary contracts, you must continually be on the hunt for the next opportunity.
No benefits or employment perks: Most employers provide benefits and bonuses for their full-time employees (like travel allowance, paid-study leave, etc.). These benefits are not available for an IC.
Extra administrative jobs: An independent contractor must handle all administrative tasks, including accounting and tax filing. But this should not be a problem with automated tools like Workee.
Workee is an all-in-one solution for independent contractors, sole proprietors, and professionals. This tool helps you manage your business efficiently while focusing on delivering value. With Workee, an independent professional has access to the following services;
Booking and Scheduling: This enables your clients to book you easily and allows you to schedule meetings with reminders to keep you on alert.
Payment & invoicing: Workee allows you to send invoices to customers and collect payment for services rendered. The automated tax administration tool can also assist you in calculating and managing your tax payments.
Personal website: Workee allows you to have a personal no-code website. All you need to do is signup, and a website will be created for you in less than 5 minutes. The website is unique, and you can easily brand it with your personal or business information.
Client management: managing your clients is important in maintaining a good business relationship. The platform provides an automated tool that helps you prepare and categorize your client list.
Video calls: This allows you to make uninterrupted video calls with your customers or connect your preferred third-party video call solution, such as Google Meet.
What is the difference between a sole proprietor and an independent contractor?
As earlier stated, independent contractors vs. sole proprietors have some major differences, and we will highlight them in this section.
First, it is important to note that both categories are business owners and fall under the classification of self-employed. The major differences are in how they render services and the classification of tax they are eligible to pay.
A sole proprietorship describes a business owned and managed by one person and not registered with the government. A small business owner who sells goods and services falls under this category. In contrast, an independent contractor is someone who renders services and gets paid but not as an employee. Companies mostly use this classification to fulfill PAYE obligations. A company pays PAYE taxes for its employees but not contractors.
Another difference is in how taxes are determined. A sole proprietor must disclose all expenses to the IRS, including earnings, losses, and recurring expenses. But an IC gets a 1099 document from all clients who paid above $600 in the past year.
Frequently asked questions on independent contractors vs. sole proprietors
Q: can a sole proprietor also be an independent contractor
A: Yes. A sole proprietor can also be an independent contractor depending on the job description and how they get paid. For instance, a software engineer may get contracts to develop an inventory management platform for a company and get paid after the task (Here, he is an independent contractor). The developer may also have already-built solutions that he sells. So while he gets a 1099 form from clients, he also files income tax from the direct sale of products.
Q: Does the sole individual proprietor get 1099?
A: If a sole entrepreneur offers services to a client and earns more than $600, he will receive 1099.
Q: Is self-employed the same as a sole proprietor?
A: Yes, a sole proprietor is classified as self-employed.
Q: Is self-employed the same as a sole proprietor?
A: Every sole proprietor is self-employed, but not every self-employed is a sole proprietor.
Sole proprietor or independent contractor
Both fields have upsides and downsides that we have outlined. Importantly, the category you fit into is determined by how you deliver your services and how you are compensated.
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