Is Contract Work REALLY Self-Employment?

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I’ve been writing a good bit in the past few weeks about the virtues of self-employment, based heavily on my own experience in turning this blog into a primary income generating venture. I believe that being self-employed may now be the new preferred way to “creating a career”, as opposed to the more traditional route of jumping on the corporate ladder—mainly since the ladder no longer seems to exist.

Today I want to take a look at contracting, since it’s become an increasingly common path into self-employment. For the record, I’ve done a good bit of contract work over the past few years so I won’t be talking (OK, writing…) hypothetically. And I still do take on contract work under the right circumstances.

OK, so you enter a contract arrangement—they have you sign a thick contract filled with rich legalese, they aren’t going to withhold taxes, you’ll be issued a 1099 at the end of the year (instead of a W2) and you’ll be required to file a Schedule C—Income from Self-employment, on your income tax returns. Wow, you’re self-employed now, right?

Not necessarily. And maybe not at all.

Many contract arrangements have nothing to do with self-employment. They’re mostly watered down jobs that have close to zero chance of ever being converted into entrepreneurship of any kind. They can be a trap if you take them on, thinking it’ll make you self-employed. No only will you not be self-employed, but you’ll be only minimally employed at that. It’s important to know when a contract arrangement really is a form of self-employment and when it’s something else.

When contracting is NOT self-employment

I’m tackling this one first because I think this is the more common situation. Some of the typical characteristics of non-self-employed contracting include:

  1. You’re required to work full-time
  2. You’re specifically prohibited from working for the company’s competitors (translation: you’re exclusive), a restriction that can even extend beyond termination
  3. The company controls where you work and the hours you keep
  4. Strict adherence to company guidelines and procedures are required—you have little or no flexibility in performing your work
  5. Your pay is entirely dependent on hours, not the results of the job performed
  6. The employer withholds no taxes—you’re paid by 1099 and must file a Schedule C with your income tax return (giving the appearance of self-employment for tax purposes)
  7. You’re responsible to a specified chain of command, including an immediate supervisor
  8. Your work is closely supervised and directed by an employee of the company—there’s no element of freelance here
  9. You can be fired without notice or cause, though the process may be called something different
  10. Since you technically aren’t an employee, you have no company benefits
  11. Since you aren’t an employee, you have no right to sue for typical employee grievances
  12. Any and all contract provisions are for the protection of the employer

A recruiter friend of mine tells me that these provisions are becoming extremely common. But a contract situation with even a few of these provisions is not self-employment in any way. And though the stipulations are quite common in today’s contract job market, a situation with even a few of these elements would not qualify as a contract situation under IRS guidelines either. That’s really a job, but one in which we, as the employees, have most of the responsibility and liability.

Employers love this arrangement because it a) relieves them of most administrative functions, including collecting and filing income taxes, b) circumvents providing employee benefits, c) allows them to terminate the “contract” at will, and d) generally denies the employee the right to bring a lawsuit for unfair practices, inadequate working conditions or for wrongful discharge.

Now if you take an assignment like this because you need a paycheck—as I have myself—you certainly have my respect. Just understand that it’s usually mostly a compromised job situation and in NO way self-employment or anything that will lead in that direction.

Your “self-employment” is only in the eyes of your employer, who loves it because it gives them all the advantages while denying you the same. The 1099/Schedule C arrangement is completely cosmetic and in no way proves self-employment status. Neither does the written contract you sign because it establishes an unequal partnership favoring the employer, and is also completely cosmetic.

When contracting IS self-employment

Recognizing that the situation described above is probably the more common contract arrangement, there are contract arrangements that very much are a form of self-employment. How do you know? Here are some clues…

  1. You have a written contract with a company to provide specific services that can, but don’t necessarily, require a certain number of hours
  2. The assignment is usually temporary, concluding when the specified services have been delivered
  3. You are free to work with competing clients simultaneously or subsequent to the assignment
  4. The client does not require you to work on site, or allows a certain amount of work to be done off site
  5. Though you may have regular interaction with client management, you are not supervised by them
  6. You can enter the contract and be compensated under your corporate name
  7. You can bill the client for expenses, such as travel, incurred in connection with the assignment
  8. Payment via 1099 (no withholding taxes) is legitimate because it’s understood by all parties that you will contract with multiple clients and may have legitimate business expenses to write off
  9. The arrangement can be part-time, seasonal or as-needed
  10. You have complete or substantial control of how the work gets done—the client specifies what they want done, but leaves it to you as a professional to make it happen
  11. The contract itself is a fully negotiated document, prepared by and agreed to by both you and the client

Contracting with these provisions is a form of self-employment. The key element is flexibility—under this kind of arrangement you have considerable flexibility because the client is relying upon your specific skill set. Compare this with the tightly controlled job-posing-as-independent-contractor in the first example and you can easily see why that one isn’t really a form of self-employment.

Why does it even matter?

Employers are concocting all kinds of ways to cut payroll costs, and contracting has become an extremely common method. What’s important is that you don’t get caught up in the employer’s claims that you’re somehow self-employed just because they hire you as a “contractor” or some similar nomenclature.

If you want to be self-employed, then you need to make sure that the contract arrangement you’re agreeing to will be a step in that direction. A contract should allow you to be free to do the work the way you need to do it, and allow you to freely solicit and work for multiple clients. That’s being self-employed.

Contract arrangements that control your time and workflow, and prohibit outside activities are just jobs by another name. If your long-term plan is to become self-employed, either through contracting or by some other method, the first situation won’t help your cause.

If you want to be an entrepreneur, you need to learn the difference between the two contract arrangements. One will bring you to self-employment, the other is really a job—and a job with less security and fewer benefits than traditional employment.

Have you ever done contract work? Have you ever been in a contract arrangement that looked a lot like the first example? How did you feel about it?

Related Posts:

How Blogging Solved My Mid-Life Career Crisis
7 Reasons to be Self-Employed
Why Most New Businesses Fail – And How Not to Become One of Them
Income Security VS Job Security – Does it Matter?
The Self-Employed Health Insurance Dilemma
7 Reasons Why Self-Employment is More Secure than a Job

( Photo from Flickr by Steve Snodgrass )

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5 Responses to Is Contract Work REALLY Self-Employment?

  1. Turns out I’m self-employed 😉 Great post on drawing the line. Since I control what jobs I take, and work with many different clients, bill under my LLC (no Schedule C for me!), and set my own schedule, I consider myself self-employed. Although, there are days when I feel like I have several bosses!

  2. Hi Miranda–As a freelance writer with MANY clients you’re most definately self-employed. I was taking aim at the contract situations that are really full time jobs with only the appearance of self-employment. I’ve done both, and recognize what a trap contract jobs can be. Especially at tax time!

  3. I agree. You don’t want to be stuck in a really restrictive agreement. I have a lawyer (my uncle or my cousin) check over agreements before I sign them, especially the NDAs.

  4. The IRS has a few opinions on this matter (http://www.irs.gov/businesses/small/article/0,,id=99921,00.html). They don’t take to kindly to companies that claim to have ‘contract employees’, when in reality they have full control over them and are claiming them as contract employees only to avoid paying payroll taxes.

    Apparently there is even an IRS Form 8919 “Uncollected Social Security and Medicare Tax on Wages” that you can fill out if you think you have been classified as a contract employee, when in actuality you are an actual employee with the ‘pleasure’ of paying your own taxes.

  5. Hi Marshall–A recruiter friend of mine says these kinds of contracts are becoming more popular than ever, even though they don’t pass muster with the IRS. And if you refuse to sign then you don’t get the job–I’m sorry, “contract”.

    There are something like 20 “tests” a contract has to pass in order to be a legitimate contract situation according to the IRS, and if it fails any one of them it isn’t kosher. Most are an attempt to get around withholding of income taxes as well as employer matching FICA taxes.

    The type of contracts Miranda has are the legitimate self-employment situations. I know, because I have several myself. Those contracts spell out the product you deliver (articles) and put zero restrictions on how you do it, or on the soliciting and maintaining of outside clients. The point is, there are legitimate contract arrangements out there, and you’ll know them by their lack of restrictions. Too many restrictions = employer friendly job arrangement.

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