How Nonemployee Compensation Works

Independent contractors who provide services to business are considered self-employed.
Independent contractors who provide services to business are considered self-employed.
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Here's a news flash: You can work for a company or other organization without being considered an "employee." Yes, there is the subclass of worker often referred to as an "intern," best known for making copies and fetching coffee. There are also an increasing number of people -- freelancers, part-timers and contractors -- who do real work without the "employee" tag. That's mostly because employers don't want the legal and financial responsibility that comes with it.

Perhaps the best way to know whether you're being treated as an employee or an "independent contractor" is to look at your taxes. If you receive a Form 1099 from your employer at the end of the year, instead of a W-2, the money that you were paid is considered nonemployee compensation. It's important to know the difference, in part because of the tax consequences that come with being labeled a "nonemployee" [source: IRS].

First, the good news: You get paid everything up front. Employers don't withhold estimated taxes from paychecks issued to independent contractors. That means you can put the dough in the bank, shove it under your mattress, invest it in exotic low-yield bonds or bet it all on 21 at the roulette table in Vegas.

The bad news, of course, is that you're probably going to have to pay some of it back to Uncle Sam at the end of the year. Depending on how much you make, you may even need to pay estimated taxes on a quarterly basis or risk being penalized come January [sources: IRS, IRS].

In fact, independent contractors are typically on the hook for more money than their traditional employee colleagues. The Internal Revenue Service considers nonemployee workers as self-employed, even if they don't actually own a business. As such, independent contractors pay both the employee and the employer share of Social Security and Medicare taxes on the money that they earn.