Understanding the difference between an employee and contractor helps you decide on the right one to hire for your business. Classifying an employee wrong has serious consequences.
There are a few differences between an employee and a contractor. One is that the employee is hired to do a specific job for another business. The independent contractor may do similar work for multiple companies, but the relationship is between two businesses where one is providing a service for the other.
If a business designates tasks and how to do them, then anyone who works for that business is an employee.
A person can work for a business and not be an employee. This person is self-employed and considered to be an independent contractor.
How to Determine Worker Status
An employer has to classify their workers correctly between an employee and contractor. Sometimes it’s difficult to do but, there are serious implications if the IRS sees your employees are classified incorrectly.
It can be costly.
For instance, if an employer calls an employee an independent contractor only to avoid paying the FICA taxes, the IRS won’t be happy. If the employer is found out, then the business owner or business could be liable for back taxes, fines, and penalties.
The IRS considers every worker an employee. If they are an independent contractor, employers need to indicate this clearly. With the use of common law principles, the IRS determines whether or not someone is an employee or an independent contractor.
What is the Difference Between an Employee and Contractor
The IRS uses 3 areas to evaluate workers. These factors can help you determine whether you want to hire an employee or a contractor.
Here are 3 factors the IRS uses to evaluate workers.
1. Behavior Control – This has to do with whether or not a company controls or has the right to control what the worker does and how they do their job.
- The employer trains and directs work.
- Hours of work are determined.
- The employer decides on the tools or equipment the worker uses.
- Someone assigns specific tasks and provides instructions on how to do them.
- A worker can set their own hours.
- Works with little or no direction or training.
2. Financial Control – Financial control refers to the business’s control over the economic elements of a person’s job.
- Employers pay employees a salary.
- Employers can restrict employees from working for others.
- They do not participate in the company’s profits or losses.
- The employer provides tools and supplies.
- An employer pays a contractor per project or by the hour.
- They can also work for other people.
- They must provide their own supplies.
- The contractor owns their own business but works for another business.
3. Type of Relationship – This deals with whether or not there are written contracts or employee type benefits.
- Employees are entitled to benefits like insurance, a pension plan, vacation pay, and sick pay.
- The type of work is directly related to the company’s core work.
- They can contract jobs with the company.
- They pay their own taxes and benefits.
Factors to Consider When Differentiating Between an Employee and Contractor
Employees are covered by a number of federal, state employment, and labor laws, whereas independent contractors are not.
When employers hire workers, they usually fill out an application form that is handled by Human Resources. If the prospect meets all the requirements, the candidate receives a conditional offer of employment. If the person accepts the position, the employer must ask for additional information such as date of birth, marital status, and citizenship status.
An independent contractor interacts with the person who wants a specific task or service completed. The contractor may complete a proposal. When the contractor accepts the proposal then they enter into a contract before they begin the job.
The pay period of an employee remains the same unless formally changed. The pay periods can vary from once a week to once a month.
Contractors get paid after issuing an invoice. Usually, they receive pay after they complete a task. If it’s ongoing work, they can issue an invoice weekly or monthly.
Taxes for Employees vs Independent Contractors
Taxes for an Employee
The law requires that the employer withholds an employee’s federal and state taxes from their pay as well as FICA taxes and Medicare must be withheld and the employer must contribute to those taxes on behalf of the employee. The employer also pays federal unemployment taxes.
Taxes for an Independent Contractor
Because an independent contractor is not an employee, no taxes are withheld or paid for by an employer. They have their own business separate from the hiring company and must pay all taxes themselves.
If you are starting a new business, it’s critical to know the difference between an employee and a contractor. You will have to choose between an employee and a contractor before hiring someone. Most small businesses start by hiring a contractor to do some work for them, but as their business grows, they consider hiring one or more employees. Also, make sure you have all your documents and everything ready before hiring someone.