Employee vs Independent Contractor – What you need to know
When it comes time to hiring employees, businesses need to decide if they want to hire somebody as an employee or if they want to work with them as an independent contractor. The difference between the two goes much deeper than if they get a W2 or 1099 at tax time.
Many employers are not clear 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 is the best fit for their company. There are advantages and disadvantages for the employer and the worker for both classifications. This article will go into the differences between hiring an employee and contracting with an independent contractor and what both 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 they are doing work for can control the result of the work. There is no employer-employee relationship. Independent contractors are considered to be self-employed and will receive 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 being done or is it ongoing?
Independent contractors have control over how they perform their work, and are not given instruction or training by the company who contracts with them.
Employees are given directed job duties, instructions for carrying them out, are subjected to evaluation and often have on the job training. Employees will usually work on a set schedule with assigned hours while an independent contractor can set their own schedule. Employees must complete all work assigned to them while an independent contractor has the freedom to turn down jobs.
While employees are on the payroll, independent contractors are not. This means that taxes are withheld for employees but not for independent contractors, who must pay their taxes directly for their federal and state taxes. Employees are paid according to a set schedule and independent contractor are paid after invoicing for work performed.
Employees are provided the tools for doing their job and all supplies. Independent contractors usually need to supply their own tools and materials but can deduct most costs from their taxes. 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, 401K, family leave, sick pay, pay matching Medicare tax and Social Security and provide 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.
Because of flexibility and a cheaper upfront cost, many business owners prefer to use independent contractors. However, the IRS is really taking a hard look at companies that hire permanent workers and classify them incorrectly as an independent contractor.
It is estimated to be 30% cheaper to hire an independent contractor over hiring an employee. However, classifying an employee incorrectly can be costly. If you hire workers who you classify as independent contractors and do not provide insurance, such as workers compensation, and they are injured and are determined to be employees and not independent contractors, then your business could face even more penalties and fines on top of what the IRS will penalize you for.
Which is better for your business?
You have more control over an employee, and while there are more regulations and laws that apply to having employees over using independent contractors, many employers like being able to control how work is performed as well as training employees to work how you would like them to work.
Depending on what your business is, 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 that they have less turn over than by using independent contractors.