Sole Proprietor vs Independent Contractor Explained

Sole Proprietors and Independent Contractors as Self-Employed People

Construction worker measuring structure on site
••• Getty Images/DreamPictures

The terms "sole proprietor" and "independent contractor" are both used to discuss self-employed people. The two terms are confusing, so let's straighten out the differences.

Coronavirus Relief Programs Include Sole Proprietors and Independent Contractors

Sole proprietors and independent contractors are self-employed and are eligible for several of the coronavirus small business relief programs:

The Paycheck Protection Program is a loan program to help businesses pay for emergency needs, including paying employees.

A Sick Leave and Medical Leave tax credit is also available to self-employed business owners who must take off work to care form themselves and their families.

And self-employed individuals are eligible for unemployment benefits.

Read more about these Small Business Relief programs during COVID-19.

What Is a Sole Proprietor?

A sole proprietor is a one-person business that has not registered with a state as a business entity, such as a corporation, partnership, or LLC. in other words, a sole proprietor is the default business type, for income tax purposes. If you start a business, count business expenses and income separately from personal expenses and income, and you do nothing to register your business with your state, you must pay your business taxes as a sole proprietor. 

What Is an Independent Contractor?

An independent contractor is someone who is working for someone else and who provides services, but who is not an employee. An independent contractor is typically a creative professional or technical person, like a designer, web expert, or IT professional.

An independent contractor is paid based on work done, either by the hour or by the job. No payroll taxes are withheld from this person's checks unless they are subject to backup withholding.

The person receives a 1099-MISC form at the end of the year showing total income received from companies for whom the contractor has worked. This form is similar to a W-2 given to employees.

Since the independent contractor is not an employee, no payroll taxes are deducted from payments to the contractor, so the contractor is responsible for paying self-employment taxes (Social Security and Medicare), along with income taxes.

Do All Small Businesses Get 1099-MISC forms for Income? 

You would only get a 1099-MISC form if you worked as an independent contractor for someone who paid you for your services. It's under the category "Services performed by someone who is not your employee" on the list of types of payment that must be reported on Form 1099-MISC.

If you are selling products, or in some other specific cases, you would not receive a 1099-MISC form, but you would get your business income from the sale of those products. 

Beginning with the 2020 tax year, the 1099-MISC is no longer used for reporting non-employee compensation. Instead, the 1099-NEC form is used to report these payments. The form is sent to workers and reported to the IRS by the end of January of the following year. 1099-NEC forms for the 2020 tax year must be sent by January 31, 2021.

Can I Be Both a Sole Proprietor and an Independent Contractor?

Both independent contractors and sole proprietors are self-employed business owners. They both keep track of business income and expenses; they both file income taxes using Schedule C (unless a different business type is chosen), and both pay self-employment taxes on their business income..

These two designations are talking about the same business, and the differences are really only are relevant to how income is received, so you can be both. For example, a sole proprietor might receive 1099 income from a contracting employer and also receive other business income from sales of a product or service. At the end of the year, all income is included in calculating the business's income tax return.

How Do I Pay Income Taxes - As an Independent Contractor or a Sole Proprietor?

If you haven't registered your one-person business like any other legal entity, such as an LLC, corporation, or S corporation, your business is considered by the IRS to be a sole proprietorship business by default.

As a sole proprietor, you report your business taxes on Schedule C of your tax return (Form 1040 or 1040-SR). The net income from your Schedule C goes into your personal tax return, along with other income. Any income from a 1099-MISC will go into the Schedule C, along with other business income.

Do I Have to Do Anything to Be a Sole Proprietor or Independent Contractor? 

You don't have to register your small business as a sole proprietor with your state, as you would have to do if you have an LLC or corporation business type. And you there's no way to register as an independent contractor; you just receive income from a 1099-MISC and report it on your business tax return.

Do I Have to Pay Self-Employment Taxes?

Self-employment taxes are taxes for Social Security and Medicare for self-employed business owners, including those who receive 1099-MISC income. Everyone who works in the U.S. (has "earned income") must pay these taxes. Employees pay through withholding from their paychecks. Since you don't have a paycheck (you aren't an employee), you don't have withholding. But you must still pay these taxes. The amount is based on your business net income for the year and it's added to your other tax liability on your 1040.

Because you don't pay self-employment taxes and income taxes by payroll withholding, you will probably need to make quarterly estimated tax payments based on your probable income for the year. if you don't make these payments, you will probably have to pay penalties for underpayment.

Article Sources

  1. IRS. "Sole Proprietorships." Accessed Apr. 11, 2020.

  2. IRS. "Independent Contractor Defined." Accessed Apr. 11, 2020.

  3. IRS. "About Form 1099-MISC, Miscellaneous Income." Accessed Apr. 11, 2020.

  4. IRS. "Self-Employment Tax (Social Security and Medicare Taxes)." Accessed Apr. 11, 2020.