Employee or independent contractor: What’s the difference?

Question: What’s the difference between an employee and an independent contractor?
I say you can tell an employee exactly what to do and when to do it but not a contractor, who pretty much sets their own hours. My friend says you have to pay employees regularly, but independent contractors only get paid by the job.
Who’s right?

Answer: You both are.
There are about 20 ways to determine whether a worker is an employee or a contractor according to the IRS, including the two you already know.

In general, there are three common-sense methods of distinguishing a contractor from an employee:

  • Behavioral, how the work is accomplished
  • Financial, employees enjoy more direct payment
  • Relationship of the parties, the type of relationship the parties have as shown by written contracts, benefits, the permanent or transitory nature of the relationship and whether the worker is considered key to the firm’s regular business.

Here are a few of the most important guidelines the IRS uses to tell an employee from an independent contractor:

  • If the worker is required to comply with instructions about when, where and how to work, he or she is ordinarily an employee.
  • The degree of integration of the worker’s services in the business operations generally shows that he or she is subject to direction and control and therefore generally an employee.
  • If the worker has the right to hire a substitute with the permission or knowledge of the business, this would ordinarily indicate a contractual arrangement and not an employer-employee relationship.
  • The establishment of set hours of work by the employer bars the worker from being master of his own time, ordinarily the right of the independent contractor.
  • Working full time for a business ordinarily indicates a worker is not free to pursue additional gainful work during set working hours, again historically the right of an independent contractor.
  • The furnishing of tools and materials by the employer indicates control of the worker hence an employment relationship.

Still not sure? The IRS will determine whether a worker is an employee. Just file Form SS-8 (PDF), Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

More detail is also available from Twenty ways to tell a contractor from an employee.