Difference Between an Independent Contractor and Sole Proprietor

Independent contractor and sole proprietor can mean the same thing or different things depending on the context. Here’s what you should know.

This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.

Definitions

Independent Contractor

An independent contractor is usually an individual who personally performs services for one or more businesses. An independent contractor usually works alone without employees. It’s common for businesses to use multiple independent contractors for the same task.

Freelancers are often commonly considered independent contractors.

Sole Proprietor

A sole proprietorship refers to a business owned by one person. The owner is a sole proprietor.

Sole proprietorships may sell products or services to individuals or businesses. Sole proprietors sometimes hire employees to help them.

It is more common to call a business a sole proprietorship when it can be sold to another person or business.

Tax Differences

Both independent contractors and sole proprietors follow the same tax rules. There is no tax difference between the two. Each can choose between several sets of tax rules.

Most don’t create a separate business entity and file Schedule C as part of their individual tax return.

Sole proprietors and independent contractors can also choose to form a corporation, S-corporation, or LLC. Corporations have separate tax returns. LLCs can use Schedule C or choose to be taxed as corporations.

Deduction Differences

Independent contractors and sole proprietors also follow the same business deduction rules. Since sole proprietorship often refers to a more complex business with more expenses, people may think sole proprietors get more deductions. The only difference is the expenses not what they could qualify for.

Business Licenses

Each area has its own business licensing rules. Some areas require any type of independent contractors or sole proprietors to get a business license. Others treat independent contractors who only work for registered businesses similar to employees and don’t require them to have a business license.

Mortgage Qualification

Some mortgage companies may treat independent contractors and sole proprietors as different things. Under federal guidelines, both need to provide two years worth of tax returns to prove income. Mortgage companies may treat independent contractors who work for one or a handful of businesses similar to employees and verify their income with each company.

Changing Your Status

Your status as an independent contractor or sole proprietor is more about how you work and present yourself. Since there’s no official distinction, you can change your status just by refining your business practices.

If you’re trying to find tax benefits, the best place to start is exploring forming a corporation or LLC. You may also be interested in small business retirement plans.

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