Sole Proprietorship vs Independent Contractor: Key Differences

People tend to think of employment as the default. However, recent data from the International Labor Organization (ILO) finds that almost half of global workers are classified as self-employed. Most people fall into one of two main categories: independent contractors (ICs) or sole proprietors (SPs).

Self-employment is such a popular model because it offers greater flexibility than full-time or part-time employment. You’re free to negotiate payment, set your own working hours, and decide which projects you’d like to take.

In exchange for this extra freedom, self-employed workers must assume more responsibilities. You can’t rely on an employer to withhold payroll tax, report income to the government, or absorb any legal risk. What’s more, you’re responsible for deciding whether you’re an IC or an SP and meeting all the local compliance requirements.

Are you considering self-employment but unsure which worker classification to choose? Read our guide to ICs and SPs to understand the key differences and decide which structure suits your situation best.

What is an independent contractor?

An independent contractor (IC) is an individual hired to perform specific jobs for another business entity. They’re also known as freelancers or just contractors. Some common examples of ICs include creative professions like writers and designers, tradespeople, and consultants.

What is a sole proprietor?

A sole proprietor (SP) is an individual who owns and operates their own business known as a sole proprietorship. They’re also called sole traders.

In most countries, a sole proprietorship is the simplest form of business ownership, as there’s no legal separation between the worker and the company.

SPs often run their own small shops, hairdressing salons, and tutoring services.

A quick overview of the differences between an independent contractor and a sole proprietor

Here’s a look at the main differences between an IC and an SP before we compare the two types of self-employment in more detail:

Business structure

The biggest difference between ICs and SPs is business structure. ICs work for companies as individuals, while SPs form partnerships with other organizations through their individually owned businesses.

In other words, ICs aren’t a legal entity but a type of worker classification. Most countries tend to categorize them according to how they’re hired and paid through the client company. Additionally, legal requirements tend to define ICs based on their differences from employees rather than other self-employed workers.

Concerned that your current work arrangement makes you an employee? Ask your client to use Deel Contractor to check your agreement and confirm it meets local criteria for self-employment classification. All they need to do is answer a few questions, and they get a verdict in minutes.

Professional relationships

ICs tend to have shorter, more transactional relationships with their clients than SPs. Although you may build trust with companies and work alongside them for years, you’re still usually seen as an external service provider.

Meanwhile, SPs usually build direct relationships with client companies. For example, a craftsperson might provide goods or materials to an ecommerce store for years. You might frequently send samples and freebies to ensure the relationship remains positive and prevent your client from going to competitors.

The difference in professional relationships isn’t limited to clients. ICs typically work for a smaller number of companies and handle all the work alone. On the other hand, SPs may have a large number of customers and hire employees or contractors to help them manage the workload.

SPs are subject to the same employment laws as incorporated businesses. Consider outsourcing hiring to an Employer of Record (EOR) service like Deel if you lack the resources to research and manage compliance. This service essentially acts as the legal employer on paper, assuming responsibility for HR, payroll, and benefits administration in the country where your workers reside.

Registration and compliance

Both ICs and SPs must meet legal requirements. In many countries, this involves paying estimated business tax, filing income tax returns, and contributing to public programs. For example, self-employed individuals in the US are expected to pay directly into programs like Social Security and Medicare taxes.

While their ongoing responsibilities may overlap, ICs and SPs often have to file different paperwork. Most notably, SPs are more likely to need to register their business and obtain a business tax number.

SPs may also bear more responsibility for managing paperwork. For instance, in the US, all self-employed workers must file Schedule C (Form 1040) as part of their personal tax return with the IRS to report all their income and expenses. However, ICs may receive Form 1099-NEC from clients documenting their total income earned during the tax year if it exceeds $600.

Revenue sources

ICs are usually service providers that perform contractual work for a set fee. They can set rates and negotiate terms, but they’re often limited by market expectations. While SPs may perform contractual work, they often have other revenue streams, like products or services they sell directly to customers.

Consider the different types of writers to understand the difference: You could work as an IC, under contractual obligation to write three blog articles per month for a client company. As you control your hours and manage your own taxes, you’re still not classified as an employee.

Alternatively, you could establish a sole proprietorship and write and publish your own book. You receive your income directly from customers instead of through a client company.

Financial and legal risk

Both ICs and SPs can be held personally liable. This includes mistakes made when providing a product or service to a company or breaches in agreements with clients or partners. This means ICs and SPs are directly responsible for any debts or lawsuits they incur through their work.

Some erroneously believe that SPs are at greater risk due to their business structure. However, the issue is usually due to the nature of the work. SPs are more likely to run physical locations or sell directly to customers, which means there are more opportunities for accidents and disputes.

All self-employed workers can benefit from purchasing personal liability insurance to safeguard their personal assets. They should also sign thorough independent contractor agreements to minimize unexpected penalties should a conflict arise. Consider asking your client to have an expert service like Deel Contractor review these after they’ve drafted them to check for potential issues.

Scaling and growth

ICs and SPs don’t have much flexibility to grow. Your business income is usually limited by the number of hours you can feasibly work or projects you can realistically take on. If you wish to expand, you must incorporate and establish a legal entity like a limited liability company or a partnership.

That said, SPs may find it easier to grow. You can start hiring employees and scaling your operations like other small business owners before you formally incorporate your business. Depending on your location, you may also have completed some of the paperwork and setup required, giving yourself a small head start.

When you’re ready for the next step, Deel can help you incorporate your business. Deel provides a white-glove entity setup service where we arrange all the tax and business registration on your behalf. This lets you focus on building a team and developing a long-term strategy instead of filing forms.

Can you be an independent contractor and a sole proprietorship?

Yes, an SP can work as an IC on the side. Sometimes you may be both types of self-employed worker by default, as the distinction comes down to how you earn income.

To understand what we mean, think back to our example of the different writers. Hypothetically, you could provide your writing services to a client company and write and publish your own book on the side. In this scenario, you would be both an IC and an SP.

However, none of your legal requirements would change. If you were operating in the US, for example, you would still report on your combined income and pay estimated quarterly taxes.

Get your work classification right the first time with Deel

Understanding worker types is crucial, whether you’re thinking of freelancing or looking to hire independent contractors. If you know your rights and responsibilities, you can achieve strong compliance with local employment laws and minimize all the risks.

Deel can support you through entity setup, hiring your first workers, and beyond. When you start freelancing, Deel Contractor can ensure you’re classified correctly so you don’t need to abruptly change your working relationship with clients later down the line. As you begin to expand, Deel Entity Setup can support you through the complex incorporation process in over 80 countries.

Sound like something you could benefit from? Book a demo with the Deel team to get to know our different services for independent contractors and sole proprietors better.