Working as an independent contractor: Benefits, challenges, and steps for your small business

Published Friday 31 October 2025

Table of contents

• What is an independent contractor?
• Independent contractor vs employee
• Independent contractor examples
• The benefits of becoming an independent contractor
• The drawbacks of independent contracting
• How to become an independent contractor
• How to find clients as an independent contractor
• How much to charge as an independent contractor
• Managing your independent contractor business
• FAQs on independent contractors

Key takeaways

• Establish proper business classification by understanding the three IRS criteria: behavioral control (you choose your methods), financial control (you use your own equipment and cover expenses), and relationship type (project-based work with defined end dates).

• Set up essential business infrastructure including choosing a business structure, obtaining necessary licenses and insurance, creating separate business banking accounts, and developing standard contracts before seeking clients.

• Diversify your client acquisition strategy by combining freelance platforms like Upwork, professional networking through LinkedIn and industry events, direct outreach with referrals, and government contract opportunities.

• Calculate your rates by researching market standards and factoring in all self-employment costs including health insurance, retirement planning, taxes, and unpaid time off, as contractors typically need to charge 20-40% more than employee equivalents to maintain similar net income.

What is an independent contractor?

You are considered an independent contractor if you meet certain criteria that set you apart from employees:

Business ownership:

• Own part or all of your business
• Supply your own materials and equipment
• Control how work gets completed

Work arrangement:

• Work for multiple companies each tax year
• Handle temporary, project-based assignments
• Maintain specialized skills or expertise

Client relationship:

• Work for limited time periods, not permanently
• Client focuses on results, not work methods

Getting classification right matters because it affects your taxes, benefits, and legal protections, and government agencies have dedicated significant resources to address worker misclassification.

Check your local rules, as guidelines vary by country.

Independent contractor vs employee

It's important to know the difference between an independent contractor and an employee. The IRS uses three main categories to decide your status. If you are unsure, you can file Form SS-8 with the IRS to get an official decision.

Behavioral control

Employees follow instructions on when, where, and how to work. Contractors choose their own methods to complete projects.

Financial control

Employees usually have their business expenses reimbursed and tools provided by the company. Contractors often use their own equipment and can deduct their business expenses, but they also cover their own costs.

Relationship of the parties

The relationship is defined by contracts. Employees may receive benefits like paid time off and health insurance, while contractors do not. The work is usually project-based with a defined end date, not permanent.

Independent contractor examples

Independent contractors work in many industries. If you provide services to multiple clients, you may be an independent contractor. Here are some common examples:

• Creative professionals like graphic designers, writers, and photographers
• Skilled tradespeople such as electricians, plumbers, and carpenters
• Professional services including consultants, accountants, and marketers
• Tech experts like web developers and IT support specialists

The benefits of becoming an independent contractor

Independent contracting offers several key advantages over traditional employment:

Greater earning potential

Contractors often earn 20–40% more than employees in similar roles. You can charge market rates for your skills and get paid for every billable hour.

Complete schedule control

You choose when, where, and how much you work. This flexibility saves you commuting time and lets you design work around your lifestyle.

Professional autonomy

As your own boss, you choose your projects, clients, and business direction.

Skill diversification

Working with different clients helps you learn new skills and work in different industries. This can make you more marketable.

Test out a new field of expertise

Not sure if there's a market for your skills? You can try a new industry without committing to a full-time job. If it doesn't suit you, you can move on quickly.

Start on a part-time basis

This approach works well for recent graduates or people looking to try a second or third career.

Test out a company

If you are unsure about a new company, suggest working as an independent contractor first.

The drawbacks of independent contracting

Being a self-employed contractor means you have different employment rights than employees. You may not have the same legal protections, and the rules can be complex. Here are some things to consider when you're a contractor:

• You'll have no income during temporary lulls in workload. This can be stressful, so you'll need to budget carefully.
• Your client doesn't have to provide you with health benefits or even (in some countries) pay you the minimum wage.
• You may not be covered by Workers Compensation or similar schemes. This may seem unfair, but you may not be treated on an equal footing with other workers.
• You won't belong to the organization you happen to be contracting for. They don't have to invite you to company meetings or involve you in strategy discussions or planning. And some full-time employees may resent you if they think you're earning more than them.
• You may not be covered under equal opportunity employment laws. This varies from one country to another – some governments apply the same legislation to contractors, but many don't.
• Taxes are not withheld and paid by your client. This means that if you don't put money aside for your year-end tax bills, you could get into trouble. Use good quality accounting software to keep track of tax owed and the contents of your savings accounts.
• If your client classifies you incorrectly, both you and your client may face extra costs. Make sure your status is correct from the start.

How to become an independent contractor

Becoming an independent contractor requires establishing your business foundation and financial systems. Here's how to get started:

1. Choose your business structure: Decide between sole proprietorship, LLC, or corporation based on liability protection and tax implications.
2. Register your business: Obtain necessary licenses, permits, and tax identification numbers for your location and industry.
3. Create a business plan: Define your services, target clients, pricing strategy, and financial projections. Consider hiring an accountant for professional guidance.
4. Set up separate business banking: Keep personal and business finances separate for easier accounting and tax preparation.
5. Obtain insurance coverage: Get professional liability and general liability insurance to protect against client claims and accidents.

It's helpful to have your own standard contract, non-disclosure agreement (NDA), and services agreement for clients to sign. Some clients may prefer to use their own documents.

How to find clients as an independent contractor

Finding contractor work requires a multi-channel approach combining online platforms, networking, and direct outreach.

You need to put in consistent effort, but these channels can help you find steady work.

If you can deliver your work online or by mail, you can find clients in other countries. Use accounting software to invoice in different currencies.

Freelance platforms

• Upwork, Fiverr, Freelancer: Bid on posted projects, build client reviews
• Toptal, 99designs: Apply for vetted, higher-paying opportunities

Professional networking

• LinkedIn: Connect with potential clients, share expertise, respond to project posts
• Industry events: Attend conferences, meetups, and trade shows in your field

Direct client acquisition

• Referrals: Ask satisfied clients for introductions to other businesses
• Cold outreach: Contact companies directly with relevant case studies and proposals

Government contracts

• SAM.gov, state procurement sites: Register as approved vendor for public sector projects

How much to charge as an independent contractor

Many contractors start as employees before working on their own. This gives you an idea of market rates and job expectations. If you are unsure what to charge, check sites like Upwork for rate information.

Estimate your hourly or project rate. Consider how much work you expect to get. Research the cost of health insurance, time off, retirement plans, and equipment.

Use accounting software to forecast your income. Careful planning helps you decide if independent contracting is right for you. Consider talking to a financial advisor before you decide.

Independent contractor compensation works differently than employee pay.

Pay structure

You earn money only when actively working on projects. No income during sick days, vacations, or between contracts.

Benefits responsibility

You must provide your own:

• Health insurance
• Retirement planning
• Disability coverage
• Vacation funding

Financial advantage

Despite these additional costs, skilled contractors often earn 20-40% more than employees. High hourly rates and tax deductions can offset benefit costs and create higher net income.

Managing your independent contractor business

Independent contractors must handle business operations that employers typically manage—accounting, marketing, project management, and client communications. The right software tools can automate these tasks and reduce administrative workload:

• Accounting and invoicing: Track expenses, send professional invoices, and manage taxes with Xero accounting software.
• Time and project management: Monitor billable hours and project progress with tools that integrate with your accounting system.
• Client communication: Use professional email, video conferencing, and file sharing platforms to maintain strong client relationships.
• Marketing automation: Manage your website, social media presence, and client outreach with integrated marketing tools.

Choose cloud-based tools that sync across devices and work together. This helps you streamline your workflow.

You can take control of your finances as an independent contractor. Get one month free and see how easy it is to manage your business with Xero.

FAQs on independent contractors

Here are some questions and answers about independent contractors.

Is it better to be an LLC or independent contractor?

An independent contractor is a tax status. A limited liability company (LLC) is a business structure. You can be both. Many independent contractors form an LLC to protect their personal assets. Talk to a legal or financial advisor to see what works for you.

Do independent contractors pay more taxes than employees?

Independent contractors pay the full self-employment tax. If you think you have been misclassified, you can use Form 8919 to report your share of uncollected Social Security and Medicare taxes after an official IRS decision. Employees split this cost with their employer. Contractors can deduct business expenses, which may lower taxable income. Keep careful records.

How much should I charge as an independent contractor?

Your rate depends on your industry, experience, and the project scope. Research market rates and calculate your business and personal expenses. You can charge by the hour, by the project, or on retainer.

Can I work as both an employee and independent contractor?

Yes, you can. Many people have a full-time or part-time job and do contract work on the side. You need to manage income and taxes for both roles separately.