Independent Contractor vs. Employee
Independent contractors and employees are similar and often confused. However, there are key differences that separate them. These differences are centered around time, money, and taxes. The breakdowns of these categories as well as who has the control, make it much easier to know the difference between the two.
What is the Difference?
An employee is typically defined as a full-time worker who is employed by a single employer. In this definition, the business or employer has much more control. This control extends to the work performed and even the hours or location of the work. A key difference is that employees are entitled to legal benefits outlined in the W-2. On the other hand, independent contractors operate their own individual business. They also have multiple clients or employers. As a contractor, they get paid through invoices they submit for the work they completed. Independent contractors are responsible for their own tools and equipment. In this case, they are responsible for their individual taxes as well as the employer side.
Test #1: Behavioral Control
The IRS has developed a categorical system to test, or properly classify, the difference between an employee and an independent contractor. The first test centers around behavioral control. This type of control describes the relationship between the employee and the control they hold over their work. Should the business employing the worker have the right to direct and control the work performed, then they are an employee. They are still employees, even if this right is not exercised. As long as the business has the control, then the worker is an employee of the business. In behavioral control, the category extends to include the type of instruction given, the degree of instruction, evaluation systems, and on the job training.
Test #2: Financial Control
The second test is financial control. Employers must ask themselves if they have the right to control the financial and business aspects of the job of their worker. Some things to consider within this classification are whether the business has made a substantial investment in the equipment the worker uses when completing their job. One difference with independent contractors is that they sustain much more unreimbursed expenses than employees
They also have the opportunity for profit or loss. In general, business should consider if their worker is free to seek business opportunities. If they are, then they are independent contractors. In this category, the clearest difference is that employees are typically guaranteed a regular wage which may be supplemented by commission. Independent contractors are paid with a flat fee for their work.
Test #3: Relationship
The last test is relationship. This classification is the most subjective, and it entails how a business and their worker perceive their interactions. The relationship can be described with a written contract but is not enough to determine a worker’s status. Benefits are a major part of this classification. Things like insurance of vacation pay are typically only given to employees. Another aspect to consider is how permanent the relationship is. With employees, the expectation is that their employment will continue past a specified period, job, or project. To be considered an employee in this category, the worker’s services need to be integral to the daily business of the company.
The three classifications by the IRS are a good guide to separate employees and independent contractors, but there are some other important things to note. A business is responsible for withholding social security, income tax, and Medicare from an employee’s wages. Independent contractors must do those things on their own. When they get paid for a job, it is not the responsibility of the business to withhold any amount of their wages. This is because independent contractors have the Self-Employment Tax. A general rule for businesses to remember is, that a worker is an employee if they have the right to control what work will be done and how. With independent contractors, their control only extends to the ending result of the work.
A Few More Key Differences
Another helpful way to classify a worker is through some key differences which categorize what kind of worker they are.
- An independent contractor has built their business around specialized services that they can provide to people. They often employ these services to multiple clients.
- Employees will most likely receive training for their job, while independent contractors require no training. This is because they already possess the skills required and bring their own expertise to jobs.
- Employers do not have control over how independent contractors operate their business, meaning they can take on additional work for clients whenever they desire.
- Employees must have a wide range of skills readily available for their jobs. However, independent contractors are only responsible for a specific task as outlined in a Scope of Work contract.
- Payment terms for independent contractors are laid out in a contract, and they are not specific salaries that are to be continued past the project or task that is outlined.
- Employers are considered clients when they hire an independent contractor. As such, they have no control over the hours they work. Only the contractor is responsible for fulfilling the specified work agreement.
- Independent contractors do not have managers designated by the client. They can not dictate how an independent contractor finishes their work.
- Independent contractors are aware of their tax responsibilities.
- An independent contractor does not receive legal protections such as unemployment, worker’s compensation, or anti-discrimination from the business they are employed by.
- Independent contractors can hire subcontractors or partners and can have their own employees to complete the outlined job. If this is the case, it should be outlined in the contract.
It is important to correctly classify workers as either employees or independent contractors. If a business incorrectly classifies them, they can be subject to heavy fines and liability for lost employment taxes. However, there are several ways to avoid this. A business can reclassify their workers using the Voluntary Classification Settlement Program. There are also several forms that can be filled out to determine the status of a worker, such as Form SS-8.
Employees and independent contractors have many similarities and can be confused. It is imperative the business correctly identify the status of their worker. Should they misclassify their worker, they could incur heavy fines. There are, however, many resources and differences that can help businesses correctly identify their worker’s status.