Sole Proprietor vs. Independent Contractor Explained

Sole Proprietors and Independent Contractors as Self-Employed People

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The terms "sole proprietor" and "independent contractor" are both used to discuss self-employed people. The two terms are confusing, so let's straighten out the differences.

Key Takeaways

  • A sole proprietor is a one-person business that has not registered a formal business entity such as an LLC.
  • An independent contractor is someone who does specific work for a company for a set fee.
  • A sole proprietor may do contract work and also earn income through the sale of goods or services.
  • Both types of business must pay self-employment taxes and business income taxes.

What Is a Sole Proprietor?

A sole proprietor is a one-person business that has not registered with a state as a business entity, such as a corporation, partnership, or LLC. In other words, a sole proprietor is the default business type, for income tax purposes. 

If you start a business and you do nothing to register your business with your state, you must pay your business taxes on your personal tax return. The business itself is not taxed separately.

You will also be responsible for paying self-employment taxes (Social Security and Medicare), along with income taxes. You must pay these through estimated taxes quarterly.

What Is an Independent Contractor?

An independent contractor is someone who is working for someone else and who provides services, but who is not an employee. An independent contractor is typically a creative professional or technical person, like a designer, web expert, or IT professional.

An independent contractor is paid based on work done, either by the hour or by the job. No payroll taxes are withheld from your checks unless you are subject to backup withholding.

As an independent contractor, you receive 1099-NEC forms at the end of the year from each company you worked for. The form shows the total income you received from that company. This form is similar to a W-2 given to employees.

Since an independent contractor is not an employee, no payroll taxes are deducted from payments to you. So, just like a sole proprietor, you’re responsible for paying self-employment taxes along with income taxes.

Difference Between a Sole Proprietor and an Independent Contractor

Both of these terms refer to self-employed individuals who haven’t set up a formal business entity. They both pay business taxes on their personal tax return and both must pay self employment taxes.

The difference is in how they earn income.

  • Independent contractors do specific tasks for companies for a set amount of money.
  • Sole proprietors may do contract work, but may also get income from other sources, such as selling their own products to customers.

Do All Small Businesses Get 1099-NEC Forms? 

You will get a 1099-NEC form if you were paid more than $600 in nonemployee compensation from a company, whether you’re a sole proprietor or independent contractor. You would then use that form to report income on your annual tax return.

If you are selling products, or in some other specific cases, you would not receive a 1099-NEC form, but you would get your business income from the sale of those products. For instance, if you have a home repair business and you repaired your neighbor’s house, your neighbor would not send you a 1099-NEC.

Note

You may also receive a Form 1099-MISC if you received more than $600 in attorney fees, medical and health care payments, rents, or some other forms of payment that are not subject to self-employment taxes.

Can I Be Both a Sole Proprietor and an Independent Contractor?

Yes, you can be both a sole proprietor and an independent contractor. 

These two designations are talking about the same business, and the differences are really only in how income is received, so you can be both. For example, a sole proprietor might receive 1099 income from a contracting employer and also receive other business income from sales of a product or service. 

At the end of the year, all income is included in calculating the business's income tax return.

How Do I Pay Income Taxes As an Independent Contractor or a Sole Proprietor?

If you haven't registered your one-person business like any other legal entity, such as an LLC, corporation, or S corporation, your business is considered by the IRS to be a sole proprietorship business by default.

As a sole proprietor, you report your business taxes on Schedule C of your tax return (Form 1040 or 1040-SR). The net income from your Schedule C goes into your personal tax return, along with other income. Any income from a 1099-NEC or 1099-MISC will go into the Schedule C, along with other business income.

Do I Have to Do Anything to Be a Sole Proprietor or Independent Contractor? 

You don't have to register your small business as a sole proprietor with your state, as you would if you have an LLC or corporation business type. And you there's no way to register as an independent contractor; you just receive income from a 1099 and report it on your business tax return.

Do I Have to Pay Self-Employment Taxes?

Self-employment taxes are taxes for Social Security and Medicare for self-employed business owners, including those who receive 1099 income. Everyone who works in the U.S. (has "earned income") must pay these taxes. 

Employees pay through withholding from their paychecks. Since you don't have a paycheck (you aren't an employee), you don't have withholding. But you must still pay these taxes. The amount is based on your business net income for the year and it's added to your other tax liability on your 1040.

Note

Because you don't pay self-employment taxes and income taxes by payroll withholding, you will probably need to make quarterly estimated tax payments based on your probable income for the year. if you don't make these payments, you will probably have to pay penalties for underpayment.

Frequently Asked Questions (FAQs)

Is it better to be an independent contractor or a sole proprietor?

One is not necessarily better than the other and you don’t have to choose. You can be both, depending on the kind of work you do. For example, if you are a freelance writer, you may sell your own writing course or tutor students in English. If you haven’t set up a formal business entity, you’re a sole proprietor. 

But you may also write articles on a regular basis for a publication or company website. In that case, you’re also an independent contractor.

Do sole proprietors need to fill out a 1099 form?

You may need to file a 1099-NEC form if you have paid $600 or more to an independent contractor (say, a lawyer) or during the tax year.

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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. IRS. "Sole Proprietorships."

  2. IRS. “Self-Employed Individuals Tax Center.”

  3. IRS. "Independent Contractor Defined."

  4.  IRS. “Instructions for Forms 1099-MISC and 1099-NEC (2020).”

  5. IRS. "Self-Employment Tax (Social Security and Medicare Taxes)."

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