Sole Proprietors are entitled to deduct all fees paid to independent contractors as a legitimate business expense. This expense is found on Line 11 of Schedule C and is described there as "Contract Labor." The purpose of this article is to help you better understand this expense and how to deduct it without worry.

Let's start with a definition of this expense. The term "contract labor" is somewhat confusing because when we use the word "labor" we often think of employee compensation such as wages and salaries. Well, Line 11 of Schedule C is definitely NOT referring to employee compensation. Rather it is referring to non-employee compensation to people such as independent contractors, consultants, and the like. These are other businesses that are providing a service to your business. These other businesses could be self-employed Sole Proprietors or other business entities such as a Corporation, Partnership or a Limited Liability Company (LLC).

In light of the above, a more succinct definition of contract labor is this: expenses paid for services rendered by non-employees.

While the word "labor" tends to confuse the issue, the word "contract" certainly helps clarify it. There are three things you can do to ensure the validity of this deduction:

1) Put the terms of your agreement with any independent contract in writing. In other words, if you are hiring an independent contractor, shouldn't there be a contract? It doesn't have to be long or elaborate, nor does it have to be drafted by an attorney. But doesn't it make good business sense to put it in writing?

2) If you pay an independent contractor $600 or more during a calendar year, and that independent contractor is a Sole Proprietor, you must issue a Form 1099-MISC to the contractor and file a copy of both Form 1099-MISC and 1096 with the IRS. Generally speaking, only Sole Proprietors should receive a Form 1099-MISC; payments to corporations are excluded from this requirement, as well as payments for products and payments to employees (who receive Form W-2 instead). Of course, there are exceptions to these general Form 1099-MISC reporting requirements, so check the Form 1099-MISC instructions for more details.

3) If you are paying an independent contractor, this contractor should be giving you an invoice for the services performed. If he/she is truly in business for himself and not an employee, isn't this just common sense?