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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.

To-Do List for Successful Relationships with Independent Contractors

The gig industry is exploding at an incredible rate, with many companies turning to the services of independent contractors as an alternative to hiring employees. As a small business owner, it is likely that you are working with contractors, and you might also offer contract services to other businesses. In fact, it is estimated that contractors will make up 40% of the workforce by 2020!

Whether you are thinking about hiring a contractor for the first time or you are already working with contractors, it is smart to consider the right strategy to protect your business, maximize results, and maintain a successful business relationship at the same time.

Benefits of Hiring Independent Contractors

Why are many companies turning to independent contractors instead of hiring employees? In decades past, it was common for a business to bring in new employees when manpower and additional skills were required. But the business climate has changed, and business owners are shifting their strategies to accommodate these differences. Here are some of the common reasons why business owners choose independent contractors:

  • Reduce Overall Costs: Since contractors are self-employed, they manage the behind-the-scenes details such as insurance benefits, employment taxes, and other admin functions. Reduce these overhead costs, and you can decrease your overall expenses for the services that are required. Plus, you have the option to hire the contractor for the weekly work that is needed, without the obligation to pay a full-time salary if you don’t need that many hours.
  • No Need for Office Space: Another way that you can reduce your costs is by eliminating the need to make space for another person in the office. Independent contractors don’t work in-office, which gives you the option to reduce your rent by selecting a smaller office space. Additionally, you don’t have the overhead expenses of office furniture, computer equipment, office supplies, and other details required for setting up an office for that person.
  • Temporary Support: Sometimes you need services for a short time, making it beneficial to bring someone in for temporary support. Paying on a project basis gives you the option to choose how long you will continue working with the contractor. When these services are no longer needed, you don’t have to worry about lay-offs or unemployment claims. These temporary contractor services are great for one-time projects such as a website redesign, or if you need seasonal assistance when you can’t keep up with the busy season in your industry.
  • Self-Management: Since you are hiring a contractor who is an expert in the industry, you don’t have to worry about high levels of management. The person is hired to handle their responsibilities in the project. You can expect those services to be completed without the need to drive the project with focused management every step of the way. Contractors tend to have higher levels of “self-starter” skills compared to standard employees.

As you can see, there are many reasons why you might consider working with a contractor instead of bringing on another employee.

Tips for Getting Started with a Contractor

Now that you can see these benefits, you might be ready to jump in by hiring contractors to assist with your workload. But there are a few must-do things that need to be completed to ensure you are protecting your company and staying in the bounds of the law. Here are a few tips that should be added to your to-do list:

  1. Tax Documents: The contractor doesn’t need to sign a W4 because they don’t have employment status with the company. A W4 is the IRS document used to calculate the Federal taxes that need to be withheld from the employee’s payment. Since you are hiring a contractor (not an employee), this person will receive a vendor payment instead of a paycheck. So, you don’t need to worry about any tax withholdings because the contractor is responsible for the necessary tax payments. The correct form that they should sign is Form W-9, which should be completed before work commences. This paperwork ensures that you are hiring someone who is legally allowed to work in the US. They will need to provide their resident or citizen information, and then this information is submitted to the IRS each year along with the amount of money that was paid for services.
  2. Send Form-1099: When a contractor is paid $600 or more in a calendar year, then you are required to file tax paperwork documenting the income. This paperwork needs to be postmarked by January 31st for the previous calendar year. Additionally, a 1096 transmittal form needs to be sent to the IRS, summarizing the payments that were provided to contractors.
  3. Signed Contract: A handshake deal is a recipe for disaster. Never assume that you have a common understanding of the project without creating an agreement that is signed by both parties. This contract lays out important details such as the payment structure, the scope of work required, and ownership of intellectual and physical property when the project is complete. While you aren’t legally required to have a signed contract, it is a smart step to protect the interests of your company.
  4. Work Expectations: Be careful about the expectations that are placed on the contractor. There is a fine line between contractor and employee, and you need to be sure that you aren’t crossing that line. For example, a contractor needs to flexibility to choose when and where the work is performed, and the worker must use their own tools for the work that is completed. If you require the worker to be on the project at certain times and you are supplying all of the equipment and materials that are required, then it is likely that the person should be paid as an employee instead. If you have questions about the difference between a contractor and an employee, then it is smart to talk to a payroll expert for advice.
  5. Maintaining Records: In the same way, you need to track employee payroll and performance, it is necessary to keep records of the details related to your contractors. Store a copy of the contract on file, as well as other essential information such as invoices that are billed for the work completed and proof of payment. Make sure there is a paper trail documenting communication and payment so that you can show the details if questioned about the payment and services provided.
  6. Payment Schedule: If the contractor demands up-front payment, then you might find yourself in a tricky situation if the work is not completed according to your agreement. It is common for payment terms to be established in advance. Make sure that you have a shared understanding about when invoices will be sent, the timeframe in which payments need to be received, and how much will be paid for the services. Many business owners have found that it was a mistake to issue full payment upfront, especially when the contractor isn’t motivated to perform or finish the work when the payment was sent in full. You might agree to a payment schedule of half up front and half upon delivery or completion. Or, create a monthly billing schedule with the contractor sending an invoice each month for the work that is completed.

These tips might seem simple, but they are essential to help you in protecting your company and maintaining a strong working relationship with the contractor that you’ve hired. A little bit of proactive work goes a long way to ensure success of the project.

Services to Outsource

When does it make sense to hire an outsourced contractor instead of an employee? Here are examples of services that you might choose to hire a contractor for assistance:

  • Online Marketing: Digital content can be produced by a contractor so that you don’t have to worry about having an in-house marketing expert in your company. Many business owners find that online marketing is more affordable and more effective when hiring a marketing firm instead of attempting a DIY approach. These services might include tasks such as graphic design, content writing, ad management, and more.
  • Bookkeeping and Accounting: Having a strong tracking system for your business expenses and financial reports is essential to ensure success with your company. The busy work of tracking transactions and managing your business financial information can take up a lot of time each week. Turn your attention to other business responsibilities by hiring an accounting and bookkeeping team for assistance instead.
  • Payroll Processing: While this topic can fall into the category of bookkeeping and accounting, it deserves mention on its own. Payroll has a long list of requirements and can be a burden on your company. Hiring independent contractors for assistance ensures that you are staying current with the latest laws and regulations.

If you are searching for a great team of independent contractors to assist with your bookkeeping and accounting tasks, then Easier Accounting is here to assist. Call us to learn about the way your small business will benefit from these available services: (888) 620-0770.