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What are the Differences Between Employees and Independent Contractors?

When you need additional workers for your business, you have the option to choose between hiring employees or engaging the services of independent contractors. Even though the services might seem similar, there are distinct differences that need to be addressed in the way each worker engages with your company. It is important that you consider your overall goals for the hire, as well as the way you want to be engaging with the worker.

In this article, we are going to talk about the differences between employees and independent contractors. Additionally, you can review the pros and cons of different classifications, to determine the structure that will work best for your business.

Examining the Relationship Between the Business and the Worker

What is the relationship that will be formed between your company and the worker? This relationship is the determining factor that shapes how the person should be paid. The IRS has specific guidelines and rules that need to be followed to ensure that you are using the right classification and payment structure for each person.

As a general rule of thumb, a person is classified as a contractor if the employer doesn’t have any say or control over what is done and how it is done. Instead, the business hires the contractor for specific deliverables that need to be met. The working relationship is only based on the result of the work, not the specifics of the day-in-day-out activities that are performed.

Here are a few considerations to help you determine if the worker is an employee or contractor:

  • Management: When an employer-employee relationship is formed, the business can control and direct the work that is performed by the worker. This includes instructions that are provided regarding when the work is completed and where the person can work. On the other hand, a contractor completes the deliverables with less management and control from the business.
  • Training: Usually, independent contractors leverage their own methods for the completion of the work, without specific training or guidance from the business. If the worker receives periodic or ongoing training about skills or task completion, then they likely fall within the category of employee.
  • Equipment: Contractors are responsible for supplying their own equipment, including computers, phones, office supplies, furniture, office space, and more. On the other hand, employees are provided all of the tools and equipment needed to complete the job. It is more common for contractors to incur unreimbursed expenses.
  • Profit or Loss: Employees are paid based on an hourly or salary structure, which means that they do not carry the risk of profit or loss. An independent contractor could be facing the potential of losses or profits, depending on the cost of supplies and the amount of time that is dedicated to the project.
  • Payment Structure: When someone is working as an employee, they are guaranteed a specific wage for the time that is worked. Paychecks are calculated based on hourly or weekly employment engagements. Most often, contractors are paid a flat fee for the work that is completed.
  • Benefits: Employees can receive benefits in addition to wages. Common benefits include insurance, paid time off (vacation and sick days), retirement contributions, and more. Independent contractors are provided payment only without benefits.
  • Length of Time: What is the permanency of the working relationship? If the person is offered work indefinitely, then it likely falls within an employee classification. On the other hand, contractors are often hired for a specific period or project without an indefinite promise of work.

Paying Your Workers

Worker classification matters because it determines how you will pay the person and whether you need to withhold taxes for income, Medicare, Social Security, and unemployment. When a person falls in the category of employee, then the employer is required to withhold the applicable taxes. Additionally, appropriate paperwork and timely tax payments need to be completed according to the deadlines set by the IRS.

On the other hand, your business is not responsible for the tax withholdings for independent contractors. Payments are made in full for the services provided. Then, the person receiving the earnings is responsible for taxation in their own filings and paperwork.

Be Careful to Avoid Misclassification

It is easy to get confused about the differences between an employee and a contractor. As an employer, it is your responsibility to stay current on these classification differences and ensure that you are handling payment structures correctly. The IRS has tests that can be used to determine a person’s working status.

The IRS has serious consequences for employers who hire workers as contractors but treat them as employees. You can’t choose a contractor classification for the sole purpose of avoiding employment taxes. If you choose to hire a freelancer or contractor, then you need to be sure the person is treated as such.

Sometimes, the agreement starts with clear expectations and structure – then it begins to shift over time. For example, the contractor might have flexibility in work times and how the work is managed in the beginning. Then, the expectations are changed as the employer increases demands regarding the management of the project. If the working relationship shifts into the category of an employee instead of a contractor, then you need to change the payment structure to match.

Differences in the Management of Employees and Contractors

The business relationship should differ depending on the classification of the worker. Here are some of the most notable differences:

  • Employment Laws: Contractors aren’t protected under labor and employment laws. But employees have certain workplace protections under these laws.
  • Hiring Process: When hiring an employee, the person submits an application and resume to the Human Resources department and goes through an interview process. When a job is offered, the new employee must provide details about citizenship status, date of birth, and marital status. On the other hand, a contractor works directly with the person overseeing the project. A proposal is submitted, then a contract is created based on the scope of work that will be completed.
  • Payment Timing: Employees are paid based on the payroll schedule, usually weekly, biweekly, or monthly. Employment laws require that payroll checks are distributed based on the agreed payment timeline. In comparison, contractors provide an invoice to the Accounts Payable department for the work completed. The terms of the contractor dictate the payment timelines and the amount that is distributed.
  • Payment Calculations: Employees are paid based on salary or hourly earnings. Contractors typically have a flat-fee agreement that is calculated based on the work that is performed.
  • Tax Reporting: Certain withholding and reporting activities need to occur for employees, as listed earlier in this article. Employers are responsible for both state and federal unemployment filings and payments. In a contractor relationship, the business is not responsible for these reporting activities.
  • Tax Documents: Employee income is reported on a W2 Form, while contractor payments are reported on a 1099 Form.

Which is Better: Contractor or Employee?

When you need more help in your company, it is better for you to hire a contractor or employee? This decision should be determined based on your overarching goals and the specific needs that will be filled.

For example, if you are looking for ongoing help and need assistance 20 to 40 hours a week, then it is likely that the worker classification will fall into the category of employee. On the other hand, if you need assistance with certain tasks and don’t require to have someone in the office at specific times during the day, then this business relationship will likely fall in the category of a contractor.

The benefit of hiring an employee is the opportunity to manage when, where, and how the job duties are completed. There are times when it makes sense to have a worker on-site for specific needs.

At the same time, there are benefits to hiring a contractor instead of an employee. One of the main benefits is the reduction in overall expenses for the work that is provided. The company doesn’t need to carry the burden of overhead costs for equipment, office space, and benefits.

Additionally, the agreement for an independent contractor can be structured for a short-term engagement. You might choose to bring these services onto the team during the busy season or for specific projects that need to be completed. This agreement can save money compared to paying the fully-burdened costs of bringing on another full-time employee.

Questions about Payroll or Contractor Payments?

If you have questions about the right way to structure the classification with your workers, then it is best to talk to an experienced team that can offer guidance along the way. At Easier Accounting, we offer much more than basic tax preparation services. Our accounting team is here to provide recommendations and implementation for payroll processing, invoice management, financial systems, and more. We partner with our clients throughout the year to ensure optimal accounting services that support the unique needs of each company.

For more information about these quality services, contact us at Easier Accounting: (888) 620-0770.