As the independent workforce continues to grow and evolve, so does the vocabulary of terminology that surrounds it. Here are a few of the most commonly used and confused terms you’ll come across in the industry.
1. W-2 vs. 1099
Worker classification is a complicated issue that has a big impact on contractor engagement. W-2s and 1099s are two different types of tax forms for two types of workers.
A W-2 tax form reflects annual compensation paid to an employee. Employers withhold payroll taxes—income tax, Social Security and Medicare taxes, and unemployment taxes—from employee paychecks throughout the year.
A 1099-MISC tax form reflects miscellaneous income paid to independent workers (non-employees). Unlike W-2 employees, independents are responsible for paying both sides of Social Security and Medicare (FICA); this is commonly known as self-employment (SE) tax. A 1099 form must be used if you make $400 or more over the course of the year.
2. Billable vs. Non-Billable Expenses
Billable and non-billable expenses are important factors to consider when clients engage the services of independent contractors.
Billable expenses are the costs a client agrees to be billed for. These may include the cost of business travel or project-specific materials. These are dollar for dollar reimbursement.
Non-billable expenses are operating costs that relate to an independent contractor’s work, but the client does not reimburse. These may include: specialized training, office space, or phone and internet costs. Non-billable expenses make up the majority of businesses costs for independents, but many of these expenses are deductible.
3. Bill Rate vs. Pay Rate
Bill rate and pay rate are easy terms to confuse, as they both factor into the decision of how independent contractors should charge for their services.
Bill rate is the amount independents charge clients pre-taxes and fees. It factors in the costs they need to cover to make their target income. This rate is the foundation on which they build their business.
Pay rate is the amount of income independents are actually paid (and taxed on) after other expenses, such as operating costs, business taxes and other fees are taken out.
4. Sole Proprietorship vs. Limited Liability Company vs. S Corporation vs. C Corporation
A Sole Proprietorship, LLC, S Corp, and C Corp are different types of business structures that independent contractors may use to structure their business.
A Sole Proprietorship is the simplest structure under which you can operate a business. It is not a legal entity; it simply names a person who owns the business and is responsible for its debts. Business income and losses are reported on the owner’s individual income tax return.
An LLC is a type of business that is formed under state laws to limit the owner’s liability. Under an LLC the owners are not legally responsible for business debts and obligations for the company (regardless of tax structure). An LLC is a legal status only; it has no impact on tax filing status. Most LLC’s are set up with the tax status of Sole Proprietorship or but they can have an incorporated (S-Corp or C-Corp) filing status as well.
An S Corp is recognized by the IRS for the purpose of federal income taxes. S Corps are not required to pay corporate income tax on company profits. Instead, all profits and losses are passed onto company shareholders who file individual tax returns and pay income tax on their share of company profits.