Employee vs Independent Contractor

 

When it’s time to hire, businesses must decide whether to hire someone as an employee or work with them as an independent contractor. The difference between the two goes far beyond whether they get a W-2 or 1099 at tax time.

Many employers are unclear on the distinction, and workers often end up misclassified, which can cause trouble down the road. Additionally, a company looking to hire new workers may not know which option best fits its needs. Both classifications have advantages and disadvantages for employers and workers. This article will explain the differences between hiring an employee and contracting with an independent contractor, and what each could mean for your company.

Employee or Independent Contractor

An employee works directly for somebody, either a person or a company. An employee can work for different companies but will receive a separate W-2 for each. If you have control over how work is done and what work is performed, then this is an employer-employee relationship.

An independent contractor is an individual who may work for a company, but has more control over how and what they do than an employee. For an independent contractor, the company can control the result of the work. There is no employer-employee relationship.   Independent contractors are considered to be self-employed and will receive a 1099 for each company or person they work with.

The IRS considers three factors in determining if a worker is an employee or an independent contractor.

1. Behavioral – Who determines how the worker’s job is performed, and is there control over what the worker does?
2. Financial – Who controls how the worker is paid? Are expenses reimbursed? Are supplies provided?
3. Type of Relationship – Is there a written contract and are benefits offered? Is there a set time for the work, or is it ongoing?

Behavioral

Independent contractors control how they perform their work and are not given instruction or training by the company that contracts with them.

Employees are given directed job duties and instructions for carrying them out, are subject to evaluation, and often receive on-the-job training. Employees usually work a set schedule with assigned hours, while independent contractors can set their own schedule. Employees must complete all assigned work, while independent contractors can turn down jobs.

Financial

Employees are on the payroll; independent contractors are not. This means taxes are withheld for employees but not for independent contractors, who must pay their federal and state taxes directly. Employees are paid on a set schedule, while independent contractors are paid after invoicing for work performed.

Employees are provided the tools and supplies needed to do their job. Independent contractors usually need to supply their own tools and materials but can deduct most costs for tax purposes. They must carefully track business expenses.

Type of Relationship

Company benefits are dictated by law, so if you have employees, you have to provide certain benefits. Benefits can include medical insurance, vacation, 401 (k), family leave, sick pay, pay matching, Medicare tax, Social Security, and workers’ compensation coverage. There is no obligation to offer any benefits to an independent contractor.

Employees are hired with the expectation that the employer-employee relationship will be ongoing. Independent contractors are often paid per job or project.

Misclassification

Because of the flexibility and lower upfront cost, many business owners prefer to use independent contractors. However, the IRS is taking a hard look at companies that hire permanent workers and misclassify them as independent contractors.

It is estimated to be 30% cheaper to hire an independent contractor than to hire an employee. However, classifying an employee incorrectly can be costly.  If you hire workers you classify as independent contractors and do not provide insurance, such as workers’ compensation, and they are injured and later determined to be employees rather than independent contractors, your business could face additional penalties and fines on top of IRS penalties. Additionally, for companies with Workers’ Compensation insurance, all independent contractor costs can be added as payroll at an audit, creating additional costs if the employee is misclassified as an independent contractor.  It is important to note, that a true 1099 Independent Contractor, who carries their own insurance and has provided proof of Workers Compensation coverage to you, will not be included in your audit.

Which is better for your business?

You have more control over an employee, and while more regulations and laws apply to employees than to independent contractors, many employers like being able to control how work is performed and train employees to work the way you want them to.

Depending on your business, that degree of control could be a deciding factor. If the work is essential to your business, needs to be done a certain way, and is long-term, then an employee is the better choice. By training employees and offering benefits, companies find they have less turnover than when using independent contractors.