Contractors vs. Employees—How It Affects You and Your Income Taxes

Last updated on October 19th, 2020

For those of you with a very specific set of skills and interests, you likely know exactly what you want to do with your life. Choosing a career isn’t something you need to think about, but there is something you may want to consider: being a contractor vs. an employee.

There are benefits to both options, and it is important to weigh each side objectively and decide which is the best choice for you. Let’s take a look at both and how they differ.

Contractor vs. Employee

Let’s start by making a distinction between the two. When you are a contractor, you work for yourself. You make your own hours, manage your time, and work your own schedule. Contractors are often hired to do a specific job, sometimes for just one project, and may work for multiple clients at the same time.

On the other hand, employees work for a company or a boss. The duties of an employee may be dictated by their boss, and they may receive training for the position.

Invoicing and Getting Paid

The biggest difference between a contractor and an employee is how finances are handled. A contractor must submit their own invoices and pay their own taxes.

As an employee, you will be required to fill out a W-2 tax form. Taxes are automatically deducted from your paycheck and paid through your employer.

Alternatively, if you are a contractor, you will fill out a 1099 form and are required to calculate and pay your own taxes. You may also be responsible for submitting estimated taxes quarterly, in addition to paying your year-end taxes.

What does this mean for your wallet?

As a contractor, your take-home pay will be higher because you aren’t paying taxes immediately. However, you are not exempt from these taxes and will have to pay them at a later date. Putting aside money to fund your tax payment is a wise idea.

Either way, a portion of your money should be rationed for your taxes. As an employee, this is automatically done for you. As a contractor, you will have to do it yourself.

Additionally, as an employee, your employer will pay half of your medicare and social security taxes. As an independent contractor, these taxes are your responsibility.

While contractors and employees can handle many of the same tasks, the biggest difference is going to be in the way finances are handled. When you’re an employee, you work under a company or a boss, and your payroll and taxes are mostly handled by the business. On the other hand, when you’re a contractor, you get to work for yourself, but are responsible for your invoices and paying your own taxes.  For this reason, it is important to understand how taxes are managed before deciding which is the best choice for you.