Independent Contracting vs. Job: 6 Things to Know About Pay

1. Your Taxes May Be More Complex (and Expensive)

Big news first: You’ll probably pay more in taxes as a contractor than you would as an employee making the same hourly rate. The IRS considers independent contractors to be self-employed, and requires contractors to follow tax rules for self-employed individuals. Independent contractors must pay income taxes (like anyone else), but they also pay self-employment taxes of 15.3%, which cover the share of Social Security and Medicare that might otherwise be covered by your employer.

Self-employment taxes may be offset by deductible expenses like health insurance, office expenses, advertising costs, mileage (or car expenses) and retirement contributions. But to take these deductions, you’ll need to track and document your income and expenses and report them on Schedule C of your tax return. This makes tax filing more complicated.

Finally, if you owe more than $1,000 in taxes for the year, you’ll be required to pay quarterly estimated taxes to avoid paying a penalty at tax time. Quarterly estimated tax payments are due in April, June, September and January (of the following year).

2. You Cover Your Own Expenses

The good news is that your qualified business expenses are tax-deductible. The bad news: You’re on the hook for a raft of expenses, including setting up and maintaining a home office, choosing and paying for health insurance and more.

Some of these expenses may be things you’re already paying for, such as your home, personal computer and internet service. However, other expenses may be decidedly extra, such as work equipment, insurance and the additional utilities you may need to operate during work hours. Your overhead will vary depending on the type and volume of contracting work you do. However, it’s unlikely that contracting will cost you nothing. Try to think through the costs of doing business and whether your contracting rate should reflect those costs.

3. Pay Can Be Unpredictable

The same flexibility that makes independent contracting appealing can also make it unpredictable. Your work isn’t necessarily steady or available whenever you want it. Some clients can be slow to pay. And the very idea of paid time off does not exist. If you’re taking time off from your contracting work, you’re almost certainly not getting paid.

Budgeting with irregular income is a key skill, whether you contract full time or use gig income to supplement your full-time job. If contracting is your only job, you’ll want to make doubly sure you have an ample emergency fund and a cushion in your checking account to cover expenses when your cash flow fluctuates.

Good credit can be helpful. Loans and credit can help smooth out income irregularities, though you also want to be mindful of not racking up substantial debt. Checking your credit regularly and maintaining good credit habits can help keep your options open—and your borrowing rates low.

4. Applying for Loans and Credit Is More Complicated

Being a contractor doesn’t directly affect your credit: It’s not one of the factors that’s used in calculating your credit score. However, if you’re applying for a loan or credit, self-employment income can require a bit more information and effort to document.

For example, on a mortgage application you may have to supply tax returns, bank statements and a current-year profit and loss statement to show your earnings. If you’ve recently started contracting, you may not have much of a documented track record to share with a lender or creditor.

5. Health Insurance Is on You

If you aren’t also working at a job with benefits, you’ll have to use your contracting income to pay for benefits like health insurance. According to the 2023 Employer Health Benefits Survey by the Kaiser Family Foundation, the average annual premium for employer-sponsored health insurance is $8,435 for single coverage and $23,435 for family coverage. If you need to buy your own, you may be able to get lower-cost health insurance through a government-run health insurance marketplace.

6. You Fund Your Own Retirement

Your contracting business doesn’t have automatic retirement contributions or a 401(k) with employer matching dollars. In fact, unless you set it up and contribute to it, your contracting business doesn’t have a retirement plan at all.

There are compelling reasons to save for retirement when you’re self-employed. You want the tax deduction. You understand the value of tax-advantaged investing. You don’t want to arrive at retirement age without a hefty war chest. Contractors have multiple options for retirement savings, including traditional IRAs, Roth IRAs and SEP IRAs. Even if you already contribute to a retirement plan at another job, you may want to open an IRA and maximize your retirement savings.

The Bottom Line

Earning money as a contractor is neither better nor worse than making your living as an employee, but it is different. Knowing the factors that can affect your contracting income can help you evaluate opportunities, set prices and understand financial position more effectively.

As a contractor, you may need to take a more active role in managing your money. Tracking your income and expenses, keeping up with estimated taxes, paying for your own insurance and making timely retirement contributions all require more bandwidth than simply collecting a paycheck. For help staying on top of your credit, consider free credit monitoring to track changes to your credit score and report.