If I Am a Contractor, Am I Self-Employed?

Many independent contractors wonder whether they are considered self-employed, an important distinction that affects taxes, legal responsibilities, and financial planning. While contractors often work independently, classification depends on specific factors.

Understanding this status helps with tax filing, recordkeeping, and choosing the right business structure.

Determining Self-Employed Status

The IRS considers a person self-employed if they operate a trade or business independently rather than as an employee. The key factor is control—if a company dictates when, where, and how work is performed, the worker is likely an employee. If the individual sets their own schedule, provides their own tools, and assumes financial risk, they are typically self-employed.

The IRS uses a three-category test—behavioral control, financial control, and the nature of the relationship—to assess worker status. A graphic designer hired for a project, using their own software and paid per assignment rather than receiving a salary, would likely be considered self-employed.

Misclassification can lead to tax and legal consequences. If a company incorrectly classifies a worker as an independent contractor instead of an employee, it may be liable for unpaid payroll taxes, penalties, and interest. Workers unsure of their classification can file Form SS-8 with the IRS for a determination.

Tax Filing for Contractors

Independent contractors handle their own taxes since they do not have an employer withholding income taxes, Social Security, or Medicare. The primary tax form used is Schedule C (Form 1040), which reports business income and expenses. Any net earnings exceeding $400 are subject to self-employment tax, calculated using Schedule SE. This tax covers Social Security and Medicare contributions, currently 15.3%—with 12.4% allocated to Social Security (up to the annual wage base limit of $168,600 in 2024) and 2.9% for Medicare. Earnings above $200,000 for single filers ($250,000 for married couples filing jointly) incur an additional 0.9% Medicare surtax.

Unlike employees who have taxes automatically deducted, contractors must make estimated quarterly tax payments due on April 15, June 15, September 15, and January 15 of the following year. Missing these deadlines can result in penalties and interest charges. To determine the correct payment amount, contractors should use Form 1040-ES, which includes a worksheet to estimate tax liability based on projected income. Underpaying by more than $1,000 may result in a penalty unless at least 90% of the total tax liability for the year or 100% of the previous year’s tax amount (110% for high-income earners) has been paid.

State and local tax obligations vary. Some states impose self-employment taxes or require additional estimated payments. California, for example, mandates an $800 annual minimum tax for LLCs, while New York City levies a 4% Unincorporated Business Tax (UBT) on net earnings exceeding $100,000. Contractors selling physical goods or taxable services may also need to collect sales tax.

Recordkeeping and Deductions

Accurate financial records help independent contractors track income, manage expenses, and comply with tax laws. Payments should be documented through invoices, bank statements, or accounting software like QuickBooks or Wave. The IRS recommends keeping financial records for at least three years, though some situations, such as filing a claim for a loss from worthless securities, may require holding onto documents for up to seven years.

Business expenses can lower taxable income if they meet the IRS’s definition of “ordinary and necessary.” Home office expenses are deductible if the space is used exclusively and regularly for business. The simplified home office deduction allows contractors to claim $5 per square foot, up to 300 square feet, while the actual expense method requires calculating the percentage of home costs allocated to the workspace. Internet and phone bills can also be deducted, but only for the portion used for business.

Vehicle expenses offer another deduction opportunity. Contractors can choose between the standard mileage rate (67 cents per mile for 2024) or actual expenses, including gas, maintenance, and depreciation.

Retirement contributions provide tax advantages. A Simplified Employee Pension (SEP) IRA allows deductions up to 25% of net earnings, with a maximum contribution limit of $69,000 for 2024. A Solo 401(k) permits both employee and employer contributions, enabling contractors to set aside up to $23,000 as an employee, plus an additional 25% of net earnings as an employer, subject to a total limit of $69,000. Health insurance premiums, including coverage for a spouse and dependents, are also deductible if the contractor is not eligible for an employer-sponsored plan through another job or a spouse’s employer.

Business Structure Options

Choosing the right business structure affects taxation, liability, and administrative requirements. Each option has distinct financial and legal implications, influencing how income is reported, how much tax is owed, and the level of personal asset protection.

Sole Proprietorship

A sole proprietorship is the simplest and most common structure for independent contractors. It requires no formal registration beyond necessary business licenses or permits. The IRS automatically classifies single-owner businesses as sole proprietorships unless another structure is elected. Income and expenses are reported on Schedule C of Form 1040, and net earnings are subject to self-employment tax.

One drawback is unlimited personal liability, meaning business debts and legal claims can be pursued against the owner’s personal assets. Unlike corporations or LLCs, a sole proprietorship does not provide a legal distinction between the business and the individual. However, it allows for pass-through taxation, meaning profits are taxed only once at the individual level rather than being subject to corporate tax rates.

Single-Member LLC

A single-member limited liability company (LLC) offers liability protection while maintaining the simplicity of a sole proprietorship for tax purposes. By default, the IRS treats a single-member LLC as a disregarded entity, meaning income and expenses are reported on Schedule C. However, the owner can elect to be taxed as an S corporation or C corporation by filing Form 2553 or Form 8832.

The primary advantage of an LLC is the separation of personal and business assets, shielding the owner from personal liability for business debts and lawsuits. This protection is not absolute, as courts may “pierce the corporate veil” if the owner commingles personal and business finances or engages in fraudulent activities. Some states impose annual LLC fees or franchise taxes, such as California’s $800 minimum tax. While an LLC does not change federal tax obligations, it can provide credibility with clients and vendors.

Partnership

A partnership is an option for contractors working with one or more individuals in a jointly owned business. General partnerships require no formal registration, but a partnership agreement is recommended to outline profit-sharing, decision-making authority, and dispute resolution. Each partner reports their share of income and expenses on Schedule K-1 (Form 1065), and profits pass through to individual tax returns.

General partners remain personally liable for business debts and legal claims. Limited partnerships (LPs) and limited liability partnerships (LLPs) offer varying degrees of liability protection. LPs require at least one general partner with unlimited liability, while LLPs shield all partners from personal responsibility for business obligations. Partnerships also face additional compliance requirements, such as filing an annual informational return (Form 1065) with the IRS.

Corporation

A corporation provides the highest level of liability protection but comes with increased regulatory and tax complexity. Contractors can choose between a C corporation or an S corporation. A C corporation is a separate legal entity that pays corporate income tax on profits (21% federal rate as of 2024), and shareholders face double taxation when dividends are distributed. An S corporation allows income to pass through to shareholders, avoiding corporate tax, but requires adherence to strict IRS rules, such as a limit of 100 shareholders and restrictions on ownership types.

An S corporation can reduce self-employment tax by paying the owner a “reasonable salary” and distributing remaining profits as dividends, which are not subject to payroll taxes. However, the IRS scrutinizes salary levels to prevent tax avoidance. Corporations also require more administrative upkeep, including annual meetings, bylaws, and separate tax filings (Form 1120 for C corporations and Form 1120-S for S corporations). While corporations offer benefits such as deductible employee benefits and easier access to capital, they may not be practical for most independent contractors due to their complexity and cost.