Differences Between an Independent Contractor and an Employee

With remote work, the gig economy, and digital nomadism disrupting the traditional employment model, a crucial question arises: What’s the difference between an independent contractor and an employee? Virtually all Americans have heard of these terms, and most have an idea of what they mean, but not everyone is aware of the important distinctions between them.

Below, we’ll go over the difference between employees and independent contractors, the tax implications of each, how they may affect your ability to work in certain countries, and more.

Why understanding your worker classification is important for US expats

Understanding differences in worker classification is especially important when it comes to taxes. Each work classification has its own tax implications, and not understanding which one you fall into could cost you thousands of dollars in back taxes, or require you to file amended tax return(s). That said, sometimes filing amended returns leads to financial benefit to the taxpayer, so either way, concerns over your work classification are worth discussing with your expat tax CPA.

Regardless of their worker classification, US citizens have unique tax liabilities

Even if you’re living outside of the US, most expats still must file an annual tax return. Whether you’re an independent contractor or employee (or sometimes, even both) affects how you approach filing US taxes. This includes which taxes you pay, which forms you file, and which tax breaks you can claim, among others. To stay tax-compliant and optimize your tax strategy, knowing your worker classification is an absolute must.

Beyond your US taxes, your worker classification can also affect how other countries tax you. Those who relocate to another country as an employee are often considered tax residents of those countries and taxed accordingly. On the other hand, independent contractors who frequently move from place to place, may not stay long enough in a country, or maintain strong enough ties there, to be classified as a tax resident. 

Independent contractors and employees: What’s the difference?

Let’s start by going over a high-level definition of “independent contractor” and “employee.”

Independent contractor status

The IRS defines independent contractors as those who have “the right to control or direct only the result of the work and not what will be done and how it will be done.”¹ A few signs that you’re an independent contractor include if you:^2,3

• Don’t receive employee benefits (e.g. pension plan, health insurance, paid time off, etc.)
• Can seek out other business opportunities
• Set your own hours
• Supply your own equipment
• Are responsible for deliverables, and maintain control of how you achieve them.

Independent contractor taxes: Fast facts

Generally, independent contractors:

• Receive a Form 1099-K from any US businesses they work with
• File an income tax return if they earn more than $400 USD in self-employment income in a given tax year
• Pay a self-employment tax of 15.3% — 12.4% for Social Security, 2.9% for Medicare — in addition to income taxes and state taxes (and, in rare cases, local taxes) as applicable
• Make quarterly estimated tax payments
• Fill out Schedule SE and Schedule C, in addition to Form 1040

Employee status

An employee is someone who performs services for a business that has a significant degree of control over their work, including what they do and how they do it.⁴

A few signs that you’re an employee include if you/your:⁵ 

• Company withholds taxes from your paycheck
• Receive benefits associated with full-time employees (e.g. pension plan, health insurance, paid time off, etc.)
• Have a boss
• Company sets your work schedule
• Company supplies your work equipment
• Must attend mandatory training and meetings

Employee taxes: Fast facts

Generally, employees:

• Must file an income tax return if they earn more than ​​$12,950 USD in gross income in a given tax year (for single filers under 65; exact limits vary based on age, marital status, and more)
• File Form 1040
• Receive a W-2 if the company they work with is US-based
• Have FICA taxes withheld from their paycheck, including the Social Security tax (6.2%) and Medicare tax (1.45%, plus .9% for anyone who earns more than $200,000 USD per year)⁶
  • Other taxes you may have withheld from your paycheck include bonus taxes (22%, or 37% on bonuses exceeding $1 million USD),⁷ state taxes, and in rare cases, local taxes
• Have income taxes withheld from paychecks after filling out Form W-4

Is there a difference between self-employed and independent contractor?

The difference between self-employed and independent contractor statuses is that all independent contractors are self-employed, but not everyone who’s self-employed is an independent contractor. Other types of self-employed workers include sole proprietors, members of a partnership, and small business owners.

Another term often involved in conversations about self-employment is “freelancer.” Freelancer and independent contractor are sometimes used interchangeably, but they can have slightly different connotations. 

The term “freelancer” often refers specifically to those who take on shorter or one-off projects, work offsite, and have a variety of clients. Independent contractor, on the other hand, often refers to those who work with companies for longer stints and who may or may not work onsite or have been hired by a staffing firm.⁸

Which work status is preferable for US expats?

There’s not necessarily one right work status for US expats — it depends largely on factors like where you plan on going, how long you’ll be there, visa requirements, etc. That being said, you may encounter additional logistical hurdles when moving abroad as an employee vs. as an independent contractor.

Is it easier to move abroad as an employee or independent contractor? 

US citizens are commonly concerned with the bottom line: Which status is going to cause the least amount of logistical and planning headaches? Unfortunately, there is no clear-cut answer here, because the best status depends on a variety of factors including where you want to move, your skillset and professional background, and more.

Moving abroad as an employee

You may be able to move abroad as an employed person relatively easily if you work at a multinational company with overseas outposts or a business with a work from anywhere policy. However, there are some challenges for employed individuals who want to move abroad. This is especially true for those who plan to stay and work in one place for a significant amount of time.

For example, US citizens will typically need a work visa to live and work in another country, which will require something called company sponsorship. Many employers are unwilling to sponsor due to how time-consuming and costly it can be.

Additionally, moving to another country for a significant amount of time may require your employer to comply with that country’s employment and tax laws, which they may not find worth the operational expense and headache.

Finally, your employer may decide that you wouldn’t be able to do your job effectively if the time zone is significantly different than that of your colleagues or customers.

Because of these reasons, many Americans seek to find a full-time job with an employer based in their host country, although, bearing the aforementioned challenges in mind, this strategy is likely best reserved for those with highly in-demand skills. 

Moving abroad as a location-independent freelancer

Freelancers often find it easier to move abroad since they organize their own contracts, work schedules, and locations. If they move around often enough, they may not even need to pay taxes in another country. That being said, moving abroad as a freelancer can have its own challenges.

To start, current or potential US-based clients may prefer to work with someone based in their own time zone or who’s closer to them. (Establishing freelance connections prior to departing can be helpful in overcoming this obstacle.) 

If you plan to move around from place to place, keep in mind that in many countries it is technically not legal to work on a tourist visa. (That said, many do assess the risk and carry on, but we would be remiss if we did not note the potential risk.)

With great mobility comes great responsibility… and often unreliable WiFi

While being your own boss and organizing your schedule may sound great in theory, freelancing comes with a host of responsibilities. These responsibilities can take on weight, leaving you feeling surprisingly lethargic or unenthused about your work. Additionally, moving around frequently makes it challenging to establish a routine, which can lead to underproductivity or burnout. 

On the other hand, moving abroad to a specific location as a freelancer comes with distinct challenges

If you plan to settle down in one particular country, you’ll likely need to secure your own visa. These visas may be specific digital nomad visas or perhaps self-employment visas, but they often require some form of foreign taxes to be paid. 

Given the plethora of pathways that exist for freelancers to move overseas, it’s just important to research your options and prepare beforehand. As we mentioned, digital nomad visas, which allow foreign remote workers to live and work there for an extended period of time, make a great starting point. 

Many people move abroad without realizing their work status impacts their US taxes

If you moved abroad without understanding your US tax obligations or how your worker classification impacted them, you may have fallen behind on your taxes. If that’s the case, don’t panic. You may qualify for the IRS’s amnesty program, the Streamlined Procedure. 

This voluntary program gives those who misunderstood filing requirements the ability to catch up on past tax returns without additional fines or penalties. To qualify for the Streamlined Procedure, your non-compliance must have been unintentional, you must not be currently under IRS investigation, and the IRS must not have already contacted you regarding past tax returns.

References 

1. Independent Contractor Defined
2. Independent Contractor (Self-Employed) or Employee?
3. Eight Signs You’ve Been Misclassified as a 1099
4. Employee (Common-Law Employee)
5. IRS 20 Factor Test – Independent Contractor or Employee?
6. Payroll Tax Rates (2023 Guide)
7. Minimum wage and tax facts
8. Independent Contractor vs. Freelancer: What’s the Difference?