When you’re building a team for your small business, you need to know how to classify the people you hire; otherwise, it could lead to a host of issues, both from a tax and labor law perspective. For example, when you hire full-time employees, you’ll need to withhold taxes from their paychecks—something you generally don’t have to do for independent contractors, who manage their own tax payments. If you have non-exempt workers on your payroll, they’re entitled to overtime pay under the Fair Labor Standards Act (FLSA)—something that doesn’t apply to independent contractors.
It’s critical that small business owners understand the terms and classifications for different types of workers, what they mean, and when they apply. But there are two terms that often get confused—sole proprietor and independent contractor.
So, the question is, what, exactly, is the difference between sole proprietors and independent contractors? Where is there overlap? And what do business owners need to know about the differences (and similarities) between the two?
What Is a Sole Proprietorship?
A sole proprietor is a self-employed individual (or “one person business”) that hasn’t registered their business with their state or under any specific business entity. Essentially, sole proprietors do business as themselves—instead of under a legal entity with an employer identification number, like a limited liability company or an S corporation.
If an individual starts a business and keeps their business and personal activity separate (for example, separating personal income and business income, whether that’s in the same or separate bank accounts, and tracking business expenses separately from their personal finances), they’re automatically categorized as a sole proprietor unless/until they register their business with the state and as a specific type of business (again, like an LLC). Many sole proprietors fall under the “freelancers” umbrella.
“Sole proprietor” is a classification that the IRS uses for income tax purposes.
What Is an Independent Contractor?
An independent contractor is a self-employed individual that’s hired by a company to perform a specific job or service. Unlike full-time employees, independent contractors have control over how, where, and when they work.
For example, let’s say a company hires an independent contractor for 15 hours per week. Legally, the company can’t tell the contractor that they need to work those hours in the company office from 9am to 12pm Monday through Friday; the independent contractor can choose to work those contracted hours however and whenever they see fit.
Because independent contractors are self-employed—and are not employees—they’re not entitled to any employee benefits (like health insurance, PTO, or workers’ compensation).
Independent contractors are also responsible for managing and paying their own taxes. Unlike employees, who receive Form W-2 at the end of the year, independent contractors receive 1099-NEC forms from any business that paid them at least $600 during the tax year. The 1099-NEC reports the independent contractor’s earnings to the IRS—and because no payroll taxes were withheld from those earnings, the independent contractor pays self-employment taxes (which covers both Social Security and Medicare taxes) as well as personal income tax on that income.
“Independent contractor” is a term used to designate a worker as a nonemployee for withholding and FICA/payroll tax purposes.
How Sole Proprietors and Independent Contractors Are Different (and Where They Overlap)
The reason “sole proprietors” and “independent contractors” are often confused is because there’s a lot of overlap between the two.
Sole proprietors and independent contractors are both self-employed. They’re both business owners. And self-employed people can be both sole proprietors and independent contractors.
So, if someone can be a sole proprietor and an independent contractor, what’s the difference between the two?
The difference is in what the classification means—and how it’s used. Sole proprietorship is a business structure used by the IRS to determine income taxes. Essentially, it tells the IRS that you’re an unincorporated, single-person business—and should be taxed as such. Independent contractor is an employment classification used by companies for payroll tax purposes. Essentially, it’s the opposite of an employee; while a company pays payroll taxes for their employees, they do not pay payroll taxes for independent contractors.
Both sole proprietors and independent contracts are self-employed. But just because someone is an independent contractor doesn’t necessarily mean they’re a sole proprietor.
Here’s an example. Let’s say you need to hire a freelance graphic designer to help with an upcoming project. Because you’re hiring them for contract work (and not as an employee), that designer will be classified as an independent contractor. As such, you won’t withhold or pay any taxes on their behalf—and instead, they’ll pay self-employment taxes on any income they earn during their freelance gig.
As a freelancer and single-person business owner, that graphic designer very well may be a sole proprietor. But they also may not; for example, for tax purposes, they may have chosen to structure their business in a different way (for example, as an LLC that elects to be taxed as an S corp).
Bottom line? The term “sole proprietor” tells you how someone structures their business. The term “independent contractor” tells you their employment status—and the tax implications that go along with it.
Is There a Difference between Being Self-Employed and a Sole Proprietor? How about an Independent Contractor?
So, now you understand the difference between the terms “sole proprietor” and “independent contractor.” But what about the difference between “sole proprietor” and “independent contractor” and “self-employed?”
The short answer? There is none. If you’re dealing with someone who is a sole proprietor, an independent contractor, or both, you’re dealing with someone who is self-employed. Sole proprietors and independent contractors both fall under the “self-employed” umbrella.
Make Sure You Understand Sole Proprietor vs Independent Contractor
When you’re building your team, it’s important to understand who you’re hiring, the different categories and classifications that go along with that new hire, and what your responsibilities are as an employer. And now that you better understand sole proprietors, independent contractors, and the differences (and overlap!) between the two, you have the information you need to uphold your responsibilities to your contractors and make sure they have the paperwork and tax forms they need to manage their taxes.
1. Introducing Yourself
Your introductory email needs to pack a lot of information into a small package. Try something like this:
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Hello Jane,
My name is John Doe and I work for ABC Agency, where we provide business insurance policies to many of Dallas' rockstar small businesses.
Congratulations on your new business, Jane's Bakery. Are you wondering if you have all the insurance you need? Or if your policies will really cover you in a pinch?
At ABC Agency, we pride ourselves on providing robust, comprehensive coverage options to companies like yours with flexible, pay-as-you-go plans.
Are you available this week to talk more about how we can help? I can help you find the most affordable rates and the best policies out there.
I look forward to speaking with you soon.
Cheers,
John Doe
2. Presenting a Quote
Once you've met with your potential client, a quick reply with their quote will get the ball rolling.
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Hi Jane,
Thanks so much for meeting with me this morning. I loved touring Jane's Bakery–I can still smell those delicious chocolate chip cookies baking! You have a great location, and I'm sure you're going to do great on Front St.
After reviewing my notes, I've pulled together an insurance quote for you (attached). I recommend a business owner's policy. A BOP includes several insurance products in one: liability, property insurance, and business interruption insurance. It offers robust coverage at a competitive price.
I'll call you in a few days to see what you think about this insurance plan. In the meantime, if you have any questions, don't hesitate to email me or call me at [phone number].
Again, thank you for your time today. I look forward to working with you in the future.
Cheers,
John Doe
3. Thanks for Purchasing a Policy
Gratitude is important! It's never a bad idea to thank your clients for their business.
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Hi Jane,
Thank you for choosing a business owner's policy with ABC Agency. We know it's so important to get the right coverage for your business, and we are honoured you've placed your trust in us.
We're excited to work closely with you, and our no. 1 goal is to make sure you're business is always protected.
Do you have any questions? We are here to help. Reach out whenever something comes to mind.
Thank you again for choosing ABC Agency to insure Jane's Bakery.
Cheers,
John Doe
4. Welcome Email
A welcome email helps clients feel like you're there to help–and can softly pitch other insurance products you offer.
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Dear Jane,
Welcome to the ABC family! We are thrilled to have you as a new customer and can't wait to meet all of your insurance needs.
As an independent insurance agency, we work with multiple insurance providers to find the best coverage options for all our customers. If you need any other type of insurance–like [include additional offerings unique to your agency, like life insurance, health insurance, home insurance or anything else]–we can help you too.
Do you want to discuss any of these policies?
Cheers,
John Doe
5. Introducing a New Product
A happy client may want to expand their business with you.
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Hello Jane,
I hope all is well with you and Jane's Bakery. I stopped in yesterday for a blueberry muffin and coffee, and they were delicious. I loved the hint of cinnamon in the muffin! Was that your idea?
I wanted you to be the first to know we are now offering commercial vehicle insurance to our policyholders. Auto insurance for your catering vans is super important since your personal car insurance won't cover them.
We're offering this insurance coverage solely to our current business clients at the moment and have some very competitive rates.
Would you like me to work up a quote for you?
As always, thanks so much for being a part of the ABC family.
Cheers,
John Doe
6. Asking For Referrals
Once your relationship is established and comfortable, let your clients help you grow.
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Hi Jane,
You've been a valuable member of the ABC family for two years now, and we so appreciate your business–not to mention the muffins you supply for our monthly meetings!
Because you are a valued policyholder, I wanted to ask a quick favour. I know you are active in the local Chamber of Commerce, and I'm hoping you might know some colleagues who would benefit from working with our insurance company.
Referrals are one of the most effective ways to connect with our community since people really trust their friends, family and colleagues. Is there anyone you'd recommend I speak with?
Remember that in addition to business insurance products, we offer everything from life insurance policies to pet insurance.
As a thank you for your help, we will send you an Amazon gift card of $100 when your referrals buy insurance from us.
Thanks so much for your help!
Cheers,
John Doe
7. Policy Renewal
If your client needs to renew their policy with you, send an email like this:
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Hi Jane,
I hope you're doing well! What a year it's been—from being listed as one of the top 5 bakeries in Dallas to being an official vendor for the city—you have so much to be proud of.
Just a heads up that your business owner's policy is up for renewal soon and will expire on June 15, 2023.
If you're still happy with the coverage, we can easily renew it for you.
Do you have some time to chat this week?
Looking forward to serving you again!
Cheers,
John Doe