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So you want to be an independent contractor?

Friday, February 19th, 2010 by Nigel Jones

Today’s post is motivated by the events that happened yesterday in Austin, Texas. For my overseas visitors, a software engineer, Joe Stack, decided to fly his light aircraft into an office building that housed the regional offices of the IRS (the American tax office). He created tremendous damage and likely murdered at least one person, while killing himself. Notwithstanding that I wrote just a few weeks ago about the propensity for engineers to be involved in terrorist acts, what is relevant about this news item is that it appears that Joe Stack’s principal complaint concerned a portion of the US tax code (via Andrew Leonard) that applies almost uniquely to consultants / independent contractors in the software / firmware field.

So while this isn’t a tax advice blog, I thought I’d weigh in on the issue, since it’s something that applies to me, and indeed anyone thinking of becoming a consultant / independent contractor in the USA.

The main issue revolves around who is an employee and who is an independent contractor. From a tax perspective this is an important distinction, because companies can avoid a lot of overhead by classifying employees as independent contractors. For example, employers avoid paying the employer contribution to social security, which for a typical engineer in the USA was around US$7000 per person in 2009. Instead the independent contractor is responsible for this payment. Conversely, independent contractors get some benefits that employees do not. For example an independent contractor can normally deduct from his taxable income the cost of travel to and from a client’s office.

Now whether one prefers employee or independent status is of course a matter of income levels and personal preference. However, what is crucial is that one not fall some where in the middle – because if you do you stand the risk of being re-classified by the IRS – at which point the tax bills can start getting very large for everyone involved. This falling in the middle tends to occur when someone is classified as an independent by the company – but acts like an employee. That is they work the same hours, and do the same work at the same time in the same location as someone who is an employee. If this describes you, or it describes a job that you are considering, then I suggest you read on.

Note that in the following, I have assumed that you want to be an independent contractor. If you are classified this way and instead want to be an employee, then do the opposite of what is advised!

Time
An independent contractor must be free to set their own work hours. Although it is OK for an organization to say you can’t work, e.g. after 9 pm or before 6 am, it is not OK for them to specify your exact work hours. Furthermore, it is important that you exercise this right. For example if you are required to be on site 40 hours a week, then to preserve your independent contractor status it would be smart to work e.g. four 10 hour days, rather than the normal five 8 hour days. I also recommend that you strive to get the right to work from your home office for a certain percentage of the time. This helps establish your home office as a bona fide work place while simultaneously bolstering your independent status.

Tools
An independent contractor is normally expected to provide their own tools. Now clearly you are unlikely to own a $25,000 spectrum analyzer. However as an independent contractor it is certainly reasonable that you provide your own computer and other tools such as compilers, email clients etc. The problem with this is that it often clashes with a companies IT policy. When this happens I strongly suggest that you sit down with the various parties (HR, IT, your recruiting manager etc) to address the issue. There are various options available, but the bottom line is you need to protect your status – and the company (if it’s on the ball) will want to do the same.

Multiple Clients
The final way in which I handle this issue is by having multiple concurrent clients. This not only helps you meet the time requirement, but it also strongly reinforces the fact that you are free to work for whom you want, when you want – almost the definition of an independent contractor.

Well that’s my practical guide to not falling afoul of the IRS rules. Hopefully for those of you contemplating going into the consulting business you’ll have found it useful.

I’ll be returning to my more normal fare with my next post. As a heads up, embedded-gurus is undergoing a major face-lift over the next few weeks, which may impact not only my posting schedule, but also all the other bloggers here.
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5 Responses to “So you want to be an independent contractor?”

  1. david collier says:

    The situation in the UK is exactly the same – there are plenty of people being paid as "self-employed" who would never stand up to any scrutiny.The biggest piece of advice is the "get yourself multiple customers" one – if you are doing highly technical stuff for 4 or 5 different people at once you will probably not get a huge amount of scrutiny on what hours you work.The other criterion used over here is "are you told what to achieve or told how to achieve it" – if you work towards project goals in your own way, that's good – if you come in each mormning and fight todays fire undr orders, it won't wash.D

  2. Nigel Jones says:

    It's been so long since I worked in the UK that I was not aware of this David – so thank you – it was very interesting. I sometimes get asked the difference between a consultant and a contractor. For me one of the major differences is exactly your last criterion. That is consultants work out how to achieve goals while contractors are given specific assignments. If you agree with the dichotomy,it sounds like 'contractors' are on pretty shaky ground in the UK.It would be great to hear from other readers how the rules work in other parts of the world.

  3. Jan Kowalski says:

    In Poland “self-employment” is art of itself. Tax system highly rewards self-employment in comparison to normal employment. Mostly due to much lower social security payments, linear tax instead of progressive and deducing expenses from income e.g car and fuel (no one cares how this car is used, your wifes car can be deduced too).
    Although big players on market does not use self-employment probably due to legal complications and company policies. It is also theoretically possible that You will be reclassified as employee by tax office, but this hardly ever happens. Smaller software company often have part of their actual employees, working for them as “external service”. Although the real consultant market isn’t that much developed.

  4. Chip says:

    Speaking as an small business employer of contractors in California, I will say that after being shaken down by the EDD, I will never again hire an independent contractor directly. I will only hire corp-to-corp, with the contractor being an employee of the other corporation. It is fine if that other corporation has only a single employee. EDD’s definitition of an independent contractor is so narrow as to be virtually impossible to fulfill and even harder to prove. Then the EDD shakes down the employer for back payroll taxes on all past contracts, while the IRS shakes down the contractor. Double-dipping at its finest.

    I’ll condemn Joe Stack, but I also understand his frustration.

    The best advice I can give to someone who wants to be independent is to form an S-Corporation and treat yourself as both your own employee and your own boss, depending on whether you are working or paying at the moment. Find a good accountant and pay your taxes.

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