In the United States, as in most developed countries, a person who works at a job is usually classified as an “employee” if they receive a salary and benefits from the employer. Employees are hired to do work that their employers need done, and they often report to a supervisor or manager with whom they have some type of relationship.
On the other hand, Independent contractors work for a number of potential employers at once and are not supervised in their work by anyone from any one company. They negotiate contracts that set out what services they will provide and what they will be paid for those services. In addition to receiving payment from companies for completing contracted tasks, independent contractors can also offer their services directly to the public.
One of the most important differences between employees and independent contractors is how they are classified for tax purposes under federal law. The Internal Revenue Service (IRS) requires all workers to pay taxes on their income. Still, it distinguishes between employees and self-employed individuals when it comes time to figure out who owes what. Employees are taxed at a higher rate, while self-employed workers are taxed at a lower flat rate.
A further distinction concerns the length of time each group spends on a job or a particular role. When someone has a permanent position with one company, even if it requires work for other companies from time to time, he is generally considered an employee. On the other hand, if the work is completed for hire on a one-time basis for several companies — or possibly even just one – that person is more likely to be classified as an independent contractor.
Generally speaking, employees are entitled to protection under the law that does not apply to independent contractors. These can include workplace safety regulations and laws barring discrimination or harassment. Employers are also required to pay their employees at least the minimum wage and follow standard guidelines for hours worked, breaks taken, and other aspects of employment. Independent contractors do not have these kinds of legal protections.
How does an independent contractor differ from an employee?
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 essential 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.
When is it better to have independent contractors rather than employees?
Independent contractors are typically less expensing and may not need any training if they are experienced in the tasks required of them.
Employees typically receive benefits such as healthcare insurance, payroll taxes (social security and medicare), woworkers’ompensation, sick days, vacation days, withhold employment taxes, unemployment insurance, overtime pay, and other perks. Independent contractors do not receive these benefits unless expressly stated in their contract.
From the perspective of your small business, an independent contractor will require less documentation than an employee. They are also a great choice when a specialized person is required for a short-term project.
What are the risks of bringing on an independent contractor versus an employee?
Without proper management of independent contractors, you can run the risk of worker misclassification, which can lead to audits, fines, penalties, lawsuits, and more.
itit’smportant to understand that with independent contractors—freelancers, consultants, self-employed professionals, side-giggers, etc., the employer should have a lesser degree of control of a W-2 employee.
Correct classification is important as misclassification can result in large fines and penalties.
If an employer misclassifies an independent contractor as an employee, the employer may be required to reimburse the employee for wages that should have been paid under the federal Fair Labor Standards Act (FLSA). This includes paying back taxes and penalties for federal and state income tax withholding, Social Security and Medicare payments that should have been made, and any employee benefits such as health insurance and retirement benefits.
Suppose you’re genuinely not sure how to classify a worker. In that case, you can file Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) to request a formal determination from the IRS on worker classification.