Understanding the Difference between an Employee and an Independent Contractor

Understanding the Difference between an Employee and an Independent Contractor

Many businesses nowadays get in trouble for not properly identifying and differentiating employees from independent contractors. Defining what it means to be an employee or independent contractor can be tricky.

According to the IRS, an organization must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay state & federal unemployment taxes on wages paid to employees. The same is not true of independent contractors. An independent contractor is paid a predetermined amount without having to withhold any taxes from his/her pay. The contractor is responsible for paying income taxes on his/her earnings at the end of the year.

Common Law principles adopted by the IRS can help define what it means to be an independent contractor. These rules provide evidence of independence and control and fall into three categories:

Financial: Are the business aspects of the worker’s job controlled by the employer? For example, an employee will not usually incur costs or make a monetary investment in the work, whereas a contractor incurs the costs associated with performing the job. This can also include how the worker is paid, if expenses are reimbursed, and who pays for tools/supplies. Employees receive a net salary after taxes have been deducted whereas a contractor is not subject to tax withholding, but will need to pay their own self-employment tax at the end of the year.

Behavioral: Does the company have the right to control how and what the worker does in their job? Independent contractors have more freedom to set their own hours, work from a place of their choosing (home or office), decide how to go about accomplishing their work, and may work for more than one employer. Employees stick to a more rigid set of hours and work structure and will most likely work for one employer.

Relationship Type: Are there written contracts or employee type benefits? In most cases, employees work “at will”, are eligible to receive overtime pay and benefits such as health and disability insurance. An independent contractor does not receive any of these benefits. Contractors are paid according to the terms of their contract and won’t receive any compensation for overtime hours worked. Typically, they are not eligible to join unions and are not protected by employment laws such as anti-discrimination and workplace safety.

To further clarify whether or not your business should treat a worker as an employee or independent contractor, make sure you access this IRS test.

April Reeves, Social Media Editor

*Payroll Partners is committed to helping clients stay informed about payroll, tax and human resource news, developments and current events. This article is intended to provide readers with general information on payroll matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular payroll practice. All efforts have been made to assure the accuracy of the information. Payroll Partners does not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular payroll practice. If you are seeking legal advice, you are encouraged to consult an attorney*