Subcontractor & Independent Consultant Taxes

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Today, we’ll be discussing the distinction between subcontractors and independent consultants. The tax implications of each classification are relevant to both employers and potential clients. If you aren’t sure where you fall between the two classifications, we’ll outline the specifications of each and how the IRS differentiates between the two. Keep reading to learn more about these non-employee positions!
 
What are Subcontractors?
A subcontractor is, as the title implies, a type of contractor. A subcontractor can be an individual or a business entity. In short, the subcontractor engages in a contract to perform a certain portion of the duties of a primary contractor’s contract. Typically, subcontractors specialize in a particular area of expertise. There are as many subcontractors as there are industries, ranging from construction to communication to food service. A subcontractor rarely engages directly with the client who is procuring their services. Rather, the subcontractor engages with the primary contractor who engages with the client. Subcontractors are considered self-employed by the IRS.
 
What are Independent Consultants?
According to the IRS, independent consultants (also known as independent contractors) are individuals who conduct themselves as businesses. Their clients have the authority to specify the end result of their work, but no authority to specify what will be done and how it will be done. Independent consultants can be classified as self-employed or as an employee of their own company; each classification has its own tax implications. Independent consultants can hire subcontractors.
 
What is the difference between a Subcontractor and an Independent Consultant?
An independent consultant engages directly with a client. They procure their own business, promise their services, and enter into contracts. They purchase their own health insurance and benefits. A subcontractor engages with a senior contractor. They apply their skills to projects brought on board by the senior contractor. They enter into what are called subcontractor agreements—which outline their roles and responsibilities, deadlines, duration, and tax liability. Independent consultants and subcontractors file their taxes differently. 
 
What are the advantages of being or hiring a Subcontractor?
As a subcontractor you have autonomy over your own time and methods. You are hired to produce a result. However you choose to come to the result has no bearing, so long as the finished product or service is high-quality and to specification. You have nearly unlimited flexibility on how you go about completing your work. As well, because you work on a contract, you need not worry about being fired abruptly. 
Contractors will often hire subcontractors because they need someone who specializes in a certain area. As well, hiring subcontractors can cut down on costs and mitigate project risks. 
 
What are the disadvantages of being or hiring a Subcontractor?
As a subcontractor you are responsible for keeping track of and paying your own income tax. This can be quite tedious and time consuming. If you don’t stay on top of your taxes, you can end up with fines or other penalties. As well, since you are not an employee, you miss out on many of the benefits given to employees by their employers, including but not limited to: health insurance, 401k, vision, insurance, etc. 
Contractors who hire subcontractors are on the hook for their subcontractor’s behavior. Even though they’re not an employee, they still represent your company. If a subcontractor fails to perform their duties or performs their duties at a subpar level, there is little recourse by way of discipline. You’ll need to shell out more time and money in order to find someone else to complete the work.
 
What are the advantages of being or hiring an Independent Consultant?
Independent consultants, much like subcontractors, are free to structure their own time and work flow. They choose where and when to work. As well, they have the final say on their health insurance carrier, office equipment, travel plans and more. Since their business is their own, their control is near total. As well, there may be some tax savings opportunities (which we’ll go into later). 
 
What are the disadvantages of being or hiring an Independent Consultant?
The downsides of being an independent consultant are twice-fold that of being a subcontractor. Primarily because, as an independent consultant, you are responsible for finding your own work. This can require copious amounts of time, energy, and money. You must pay for your own marketing and advertising. You must convince each new client of your expertise and trustworthiness. This can, at least in the beginning, distract from the work you got into business to do. 
As well, there are numerous expenses. Everything you have the final say on—health insurance, 401k, vision, dental—you must also pay for. 
Then there are the administrative tasks to consider. Bookkeeping, invoicing, and preparing for tax season fall on your to-do list as an independent consultant. 
 
Why are neither of these classified as employees?
The IRS uses three considerations when determining whether someone’s position classifies as an employee. 

1. Behavioral
2. Financial
3. Type of Relationship

 
The first category is concerned with the degree to which another party controls when, where and how the work is done. As previously stated, both the subcontractor and the independent consultant are free to choose where they work, when they work, and in what manner the work is completed. 
The second category is concerned with who holds the responsibility for expenses related to work. In the case of the independent consultant, the answer is the independent consultant. These work-related expenses can be deducted from their income tax at the end of the tax year, but the consultant must shoulder these costs until then. In the case of the subcontractor, they may or may not be responsible for work-related expenses, as this depends on the primary contractor. However, most subcontractors are responsible for providing their own tools and necessary equipment.
The third and final category is concerned with the relationship between the business and the worker. Is there a written contract between the two parties? Does this contract specify the duration of the relationship and any benefits provided? 
These three considerations are what preclude both subcontractors and independent consultants from the employee classification. 
 
Tax Implications of Both Classifications
Subcontractors who made over $600 will be issued 1099 forms at the end of the year by their primary contractor. These statements include the total amount paid out to the subcontractor in that tax year. The subcontractor will need to gather any business expense receipts. Anything which was bought in order to generate, maintain, or perform business is deductible (i.e. cell phones, office supplies, tools, self-employed health insurance). If you use a room in your home as your sole office, you might even be able to deduct its cost from your income tax. You’ll also need a 1040 Schedule C - Profit or Loss From Business form, which you can download from the IRS website. 
As an independent consultant, things are a bit more involved. You’ll need an Employer Identification Number (EIN), which can be obtained free-of-charge on the IRS website. Then, you’ll need an account on the Electronic Federal Tax Payment System (EFTPS). You will need to pay unemployment taxes, potentially at the state and federal level. As well, you may need to pay payroll taxes. 
 

 
The freedom of being a subcontractor or independent consultant comes with an added sense of responsibility. You must stay on top of your finances. We recommend you consult a tax professional, especially if this is your first year as either classification. We also recommend paying your taxes quarterly instead of annually to avoid running into any problems at the end of the year. If you’re diligent and detail-oriented, there’s nothing to stop you from being a successful subcontractor or independent consultant.
 
Check back into the Hoods Tax & Accounting blog for more information on taxes, saving, and financial literacy! We’re here to help in any way we can! If you have any questions or are interested in a consultation, we are providing meetings over Zoom. For any other assistance, please reach out by calling or emailing! Thank you for reading. Until next time!