Employee vs. Independent Contractor

Employee Vs Independent Contractor

The difference between an employee vs independent contractor can be confusing. It is important for business owners to know if the people providing services are employees or independent contractors (also referred to as self-employed). This is because businesses have to withhold income taxes, Social Security, and Medicare from employee's checks.

They also need to pay unemployment tax on employee's wages. These do not have to be paid to someone who is self-employed (otherwise known as an independent contractor.)

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Are You An Employee or Independent Contractor?

An independent contractor is a business owner who provides his services to others. You are considered self-employed if you:

  • Own a business or trade as the sole proprietor
  • Trade with a partner or own a business
  • Engage in a business by and for yourself

If a business owner hires you to provide a service, or perform a duty, then you are not an independent contractor, you are an employee, and he is your employer.

If you are a business owner remember it is up to you to determine whether those you hire are your employees or independent contractors. You first need to understand your business relationship before you can determine how to pay for services.

What is the Difference Between an Employee Vs Independent Contractor?

Independent Contractors

Accountants, auctioneers, contractors, subcontractors, dentists, doctors, and dentists, and many others are often considered independent contractors because they are part of a profession that offers their services to the public.

However, whether they are labeled as independent contractors or employees depends upon a few things: one is considered an independent contractor if the person paying for the service only has control of the end result, and not how the job is done. This person is responsible for paying a Self-Employment Tax.

If one is told what to do, and how to do it, then this person is not an independent contractor. Even if the employer gives the employee freedom to do things his own way, the employer still has a legal right to tell his employee what and how to do things if he so chooses.

Employee

Common-law rules states that if you can tell somewhat you hire what to do, and how to do it, then they are your employee and you are their employer. You can give your employee freedom of action, but you still have complete legal control of what services they perform for you.

Comparison Between Employees and Independent Contractors

The best way to determine whether someone is an independent contractor or an employee is to consider what degree of control those hiring them have.

Common-Law Rules

Providing evidence of degree of control falls into three distinct categories:

  1. Behavioral: Does your company have complete control over what your worker does and how your worker does his job?
  2. Financial: Do you control when your worker is paid? Do you supply all the tools and supplies? Do you decide whether or not to reimburse expenses?
  3. Relationship: Do written contracts exist that outline such things as insurance coverage, vacation pay, pension plans, etc.? Is this work vital to your business, and is this relationship going to continue?

Behavioral Control

Behavioral control is all about whether one has the right to control or direct how a worker does his job. If the business has this right, then the worker is considered an employee. While the business does not have to control the way the work gets done, it does have the right to do so if desired.

Common Law Rules

Employee

Independent Contractor

Type of Instructions Given

Generally subject to the business’s instructions about when, where, and how to work.

Generally NOT subject to the business’s instructions about when, where, and how to work.

Degree of Instruction

More detailed instructions indicate that the worker is an employee
Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.

Evaluation System

If an evaluation system measures the details of how the work is performed, then these factors would point to an employee.
If the evaluation system measures just the end result, then this can point to either an independent contractor or an employee.

Training

Business provides the worker with training on how to do the job in a particular way.
Independent contractors ordinarily use their own methods.

Financial Control

Financial control deals with whether or not the business can control all aspects of economics related to the worker.

Common Law Rules

Employee

Independent Contractor

Significance of Investment

Often NO significant investment in the equipment he or she uses in working for someone else

Often HAS significant investment in the equipment he or she uses in working for someone else

Reimbursement of Expenses

More likely to have reimbursed business expenses
Less likely to have reimbursed business expenses

Opportunity of Profit or Loss

Minimal or NO possibility of bearing the profit or loss of the business
Have the opportunity and possibility to incur and bear the profit of loss of the business

Ability to Offer Services to the Market

Generally not free to seek other concurrent employment opportunities
Generally free to seek out business opportunities often through advertising, visible business location and are available for work in the relevant market

Method of Payment

Generally guaranteed a regular wage amount on a regular basis

Paid a flat fee for the job but can also be paid hourly.

Type of Relationship

Type of relationship deals with all facts pertaining to how the business and the worker perceive their working relationship.

Common Law Rules

Employee

Independent Contractor

Written Contracts

Not sufficient to determine the worker's status

Not sufficient to determine the worker's status

Employee Benefits

Generally an indication a worker is an employee. Lack of benefits is not an indication that a worker is an independent contractor
Generally no benefits

Permanence of Relashionship

Generally employment expectation is indefinite
Generally for a specific project or specific period.

Services Provided as Key Activity of the Business

Worker provides services that are a key aspect of the business and business has right to direct and control his or her activities
Worker provides services that are not key or core of the business and therefore less control of the process

Determination

Each of these factors is important when a business needs to determine whether a worker is an independent contractor or an employee. Some of these factors may point to a worker being an independent contractor, while others may indicate he is an employee.

Nothing is set in stone about whether one is an independent contractor or employee, and there is not a single factor that determines which category a worker falls in. Factors that may be relevant in one instance may not be relevant in others.

The key to unlocking this mystery is to take into account the relationship, determine the degree of right to control and direct, and document these to make a final determination.

Form SS-8

If, after reading the above, one is still unsure whether their worker is an independent contractor or an employee, they can file Form SS-8 with the IRS. The worker or the business can file this form. The IRS reviews all circumstances and facts related to the case and makes the official determination on the worker's status.

This process can take up to 6 months just to get a final determination. All businesses that hire this same type of people to work for them should think about filing Form SS-8.

Tax Obligations

After a final determination of worker's status is decided (either by the business owner or IRS), it is time to file the right forms and pay any and all taxes due.

Independent Contractor Forms

Form W-9

If you are paying an independent contractor then they should complete Form W-9, also titled Request for Taxpayer Identification Number and Certification. This form is used to learn the right name and TIN (Taxpayer Identification Number) of your worker. TINs can be a SSN (Social Security Number) or an EIN (Employer Identification Number). This form should be kept on file for at least four years, just in case it is needed for future reference by the IRS or the worker.

Form 1099-Misc

Form 1099-Misc is used to report all payments made in the trading of services for cash. If you pay someone $600. or more in a year, you must complete a Form 1099-Misc and provide it to the independent contractor by January 31st of the next year. You also need to send a copy of the worker's form to the IRS. You have until March 31st if your business files 1099s electronically; otherwise, you have send the form to the IRS by February 28th.

Employee Forms

Form I-9

Also known as The Employment Verification Form I-9, this form pertains to U.S. Citizenship and Immigration Services. Employer's use this form to verify the identity of their employees and to make sure they are eligible to work in the United States.

Form W-4

Your employee fills out Form W-4 so that the correct amount of federal income tax is taken from their check.

Form W-2

At the end of every fiscal year workers must file a Wage and Tax Statement, otherwise known as Form W-2. All wages, tips and compensation received must be entered on the form. Businesses can use Form W-3 (Transmittal of Wage and Tax Statement) to send Copy A of Form W-2 to the IRS.

Misclassifying Employees

If you say your employee is an independent contractor, and have no reasonable basis for this classification, you might be held liable for paying that worker's employment taxes.

If you can show you have reasons to treat an employee as an independent contractor, then you might not have to pay their taxes. You will need to file all federal information returns that show you are consistent in the way you have treated this employee. You must prove that no former (or current) worker who performed the same services was listed as an employee any time after 1977.

About the Author

I live in the intersection of technology and entrepreneurship. I am a technology enthusiast but my passion is helping small businesses succeed, including mine. When I am not working, you will find me goofing with my wife and kids. When not with family and/or friends, you will find me doing some home improvement projects.

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