Employee vs Independent Contractor

Every day in the U.S., business owners are paying employees to perform the necessary functions and duties related to operating a business.  We hire employees to meet our primary business needs but often we also find the need to hire individuals to help with the ancillary services and occasional projects that arise. Depending on your business type, this may include hiring workers for office cleaning, computer services, advertising work, equipment maintenance or perhaps even transportation. This month we will be focusing on the very important question; is the worker you are utilizing an employee or an independent contractor?

The employee/contractor classification has important implications for both the employer and the worker and demands careful consideration when deciding upon a classification.   For the employer, distinguishing the difference between the two types of workers is important from two perspectives, labor cost and legal obligation. An organization’s labor cost rises significantly when it employs an “employee,” namely in the area of payroll taxes and Social Security and Medicare employer matches.  Employers are also required to file quarterly and annual payroll tax returns as well as issue an accurate W2 to each employee at year-end. 

When employing an independent contractor, there are no employer obligations related to payroll taxes or withholdings.  Instead, the employer simply pays the contractor for the services provided and, if over $600.00 in the calendar year, supplies the worker with a Form 1099 at year-end. The worker is then responsible for properly reporting the income.

While the two classifications, employee or independent contractor, may seem simple to understand in practice, the determination of a worker’s legal classification is often a very gray area for employers. 

For the worker, there can be definite benefits in being an independent contractor. By definition, you have flexibility and control of when and how the work is performed as well as the opportunity to work for multiple entities.  Many independent contractors also find satisfaction in working for themselves.   In contrast, there are two main advantages of being considered an employee. The first is in the employer obligation and employee right to unemployment insurance, worker’s compensation and the occupational safety and health laws.  The second is the employer match of all Social Security contributions.

Who and what factors determine whether a workder is an employee or independent contractor?  Neither the business owner nor the worker has the option to select his or her category based simply on preference.  The IRS makes that provides by providing common law rules to guide us.  In evaluating the worker's status, "all information that provides evidence of the degree of control and independence must be considered."  Evidence of control questions to consider include:

     - Who controls what the worker does and how the worker performs the work?

     - Who controls the worker's schedule and is there a time clock?

     - Who is providing the tools and supplies being used?  Are expenses being reimbursed?

     - How long is the work relationship expected to continue?  Temporarily or indefinitely?

     - Is the work performed a key aspect of the business?

No single question is more important than another so it is important to look at the entire relationship in coming up with a classification.  In general, the more control the employer has over the relationship, the less likely the worker can be considered an independent contractor.

Worker classification is a complicated area and this information is intended as a broad overview.  If questions still remain, please consult with your human resources department or tax advisor. The legal and tax implications of misclassification are important enough that great care be taken when determining the type of business relationship you are in.