Independent Contractor vs Employee: The Complete Guide

6 min read

The line between being an employee and an independent contractor has never been more important—or more blurred. In 2025, more than 70 million Americans are estimated to be part of the gig economy, representing approximately 36 percent of the total workforce. Understanding the distinction isn't just legal semantics; it affects your taxes, benefits, career trajectory, and earning potential.

Whether you're considering launching your freelance business, already working remotely as an independent contractor, or trying to understand your current work arrangement, this guide breaks down everything you need to know.

The Fundamental Difference: Control vs. Independence

At its core, the distinction between employees and independent contractors boils down to one word: control.

The facts that provide this evidence fall into three categories – behavioral control, financial control, and relationship of the parties. Behavioral control covers facts that show if the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means.

Think of it this way: An employee is told what to do and how to do it. An independent contractor is told what result is needed, but decides how to achieve it themselves. This fundamental difference ripples through every aspect of your working relationship.

For more detailed information on classification criteria, the IRS provides comprehensive guidance on distinguishing between these two worker types.

Why Classification Matters for Your Freelance Business

Getting your classification right isn't bureaucratic paperwork—it's the foundation of your freelance business strategy. The stakes are remarkably high for both workers and companies.

Tax Implications

Generally, you must withhold and deposit income taxes, Social Security taxes and Medicare taxes from the wages paid to an employee. Additionally, you must also pay the matching employer portion of Social Security and Medicare taxes as well as pay unemployment tax on wages paid to an employee. Generally, you do not have to withhold or pay any taxes on payments to independent contractors.

As an independent contractor, you're responsible for paying your own self-employment taxes—both the employer and employee portions of Social Security and Medicare. This typically adds up to about 15.3% of your net earnings, on top of regular income taxes.

Employees, on the other hand, have taxes automatically withheld from their paychecks, with employers covering half of the Social Security and Medicare contributions. Employees receive a W-2 form each year, while independent contractors are issued a 1099-NEC once payments reach the reporting threshold, currently $600 for 2025, increasing to $2,000 in 2026.

The Cost of Misclassification

Misclassification isn't a minor paperwork error. In 2015 FedEx settled a class action lawsuit for $228 million after it had mistakenly classified 2,300 truckdrivers as independent contractors when they should have been employees.

The consequences affect both sides of the relationship. Workers misclassified as contractors miss out on overtime pay, unemployment insurance, and other employee protections. Companies face back taxes, penalties, and potential lawsuits.

The Growth of Independent Contracting

Remote work has accelerated a trend that was already gaining momentum. With respect to alternative employment arrangements on the sole or main job, 7.4 percent of all workers were independent contractors, 1.7 percent were on-call workers, 0.6 percent were temporary help agency workers, and 0.5 percent were workers provided by contract firms.

But raw statistics don't tell the whole story. Together, these trends suggest that the long-run growth in IC labor in the U.S. cannot solely be attributed to individuals seeking supplemental income, or to the rise of a few online · platform firms, but may represent a structural shift in the labor market, particularly for women.

The earnings potential is also shifting upward. In 2025, a record 5.6 million Independent workers reported earning more than $100,000 annually—well above the typical U.S. worker salary of approximately $66,000. That's a nearly 19% increase from 4.7 million in 2024 and almost double the number from 2020 (3 million).

Who Chooses Independent Contractor Status?

Contrary to the narrative that gig workers are forced into precarious employment, most independent contractors prefer their arrangement. As in prior surveys, independent contractors overwhelmingly preferred their work arrangement (80.3 percent), whereas 8.3 percent would prefer a traditional work arrangement.

This preference spans across industries. The likelihood of being an independent contractor was highest in the following occupations: arts, design, entertainment, sports, and media occupations (28.1 percent); personal care and service occupations (19.7 percent); construction and extraction occupations (15.1 percent); and building and grounds cleaning and maintenance occupations (13.2 percent). By industry, workers in real estate and rental and leasing (24.2 percent) and construction (18.5 percent) were among the most likely to be independent contractors.

Building a Sustainable Freelance Business

Understanding the technical classification is just the beginning. Here's how to leverage independent contractor status to build a thriving remote work career:

Price Your Services Strategically

Remember that you're covering costs that employees don't think about: health insurance, retirement contributions, paid time off, and both sides of payroll taxes. Your hourly rate needs to account for these factors.

Contractors are paid based on the successful completion of the work at a set fee versus a flat 40-hour work week, for example. With no benefits involved, compensation for an independent contractor is based on the value of the work alone. A contractor will present their own salary breakdown, which may be by the hour, by the quantity, by the piece, or by the entire project.

Establish Multiple Client Relationships

One hallmark of genuine independent contractor status is working for multiple clients. This not only strengthens your classification but also provides income stability and diverse experience. 82% of freelancers report more job opportunities in 2025 than the year before, largely due to remote hiring expanding their potential client base.

Invest in Your Own Tools and Training

Independent contractors typically use their own equipment and continuously develop their skills. This investment pays dividends: freelancers spend 10 times more time learning new skills than full-time employees.

Document Everything

Maintain clear contracts that specify you're an independent contractor, outline deliverables rather than work hours, and establish payment terms. This documentation protects both you and your clients from classification issues down the road.

Red Flags That Suggest Employee Status

Even if your contract says "independent contractor," certain working conditions might indicate you're actually an employee in the eyes of the IRS:

An individual working remotely, for example, performing services for you from a location other than an office operated by you, is your employee under the common-law rules, if you can control what will be done and how it will be done. Remote work alone doesn't make you an independent contractor.

The Future of Independent Work

The trajectory is clear: independent contracting will continue growing as a cornerstone of the modern economy. It's projected that in 2027, 86.5 million people will be freelancing in the United States and will make up 50.9 percent of the total U.S. workforce.

This shift represents more than just numbers—it's a fundamental restructuring of how work happens. Companies gain access to specialized talent without the overhead of full-time employees. Workers gain flexibility, autonomy, and often higher earning potential.

For those building freelance businesses, this creates unprecedented opportunity. The key is understanding the rules, structuring your business properly, and positioning yourself to capture the benefits of independent contractor status while mitigating the risks.

Taking Action

Whether you're just starting your freelance journey or reevaluating your current work arrangement, understanding the independent contractor vs employee distinction empowers you to make better decisions.

If you're unsure about your classification, the IRS offers Form SS-8 for official determination. Companies can also participate in the Voluntary Classification Settlement Program to reclassify workers with reduced penalties.

The freelance economy isn't a temporary trend—it's the future of work. By understanding the legal framework, tax implications, and strategic advantages of independent contractor status, you can build a sustainable, profitable freelance business that plays by the rules while maximizing your earning potential.

For comprehensive information on self-employment tax obligations, visit the Wikipedia article on self-employment, which provides an excellent overview of the global context for independent work.