The way people work is changing. An increasing number of people are now choosing to become independent contractors due to job uncertainty and economic changes. A recent survey found that 14% of workers now claim that being an independent contractor is their primary job. This is changing the way companies employ their workforce and forcing employers to evaluate the pros and cons of hiring an independent contractor vs. an employee.
Employee vs Independent Contractor: What is the difference?
Hiring a contract worker rather than a full-time employee could save your business money. However, choosing this option also comes with limitations and potential risks. Before you decide which type of worker to use for a given role, it’s critical to understand the differences between contractors and employees and the consequences of misclassifying workers.
Some differences will make you more thorough with how employees and independent contractor’s function.
An employee works for an employer, whereas an independent contractor has one or more clients.
Employees have a regulated schedule and work according to the company’s schedule, but an Independent contractor sets their hours.
Employees receive tools and reimbursements from the employer, but in the case of an Independent contractor -they have their tools, and they cover their expenses.
Employees receive onboarding and training from the employer, but an independent contractor with skills and expertise needs no training or only a little training.
An employee shares taxes with the employer and has taxes withheld from gross pay. On the other hand, independent contractors pay self-employment taxes.
Employees receive benefits like health insurance and retirement contributions, but Independent Contractors don’t receive any benefits or FLSA protections.
Employee gets direct supervision from a manager but a contractor controls his process.
Requirements of an Employee vs. Independent Contractor
Employee requirements are basic needs of an employer to identify what skills, competency knowledge, experience, and expertise an employee is supposed to have to meet the needs of the company. The term is used in employee management to describe an employer’s demands to the existing workforce as well as to new employees. Along with a job description, employee requirements are used to clearly define and spell out the responsibilities and duties of a specific job. Requirements for existing and prospective employees are usually established by determining what’s demanded for optimal performance. The following factors are considered:
Work results expected
Specific job requirements (incl. education, experience, skills)
Working environment conditions (incl. relationships with colleagues and senior management)
Company requirements (cultural fit, values)
Desired individual and group behaviours.
To qualify as an independent contractor, you need to:
1. Work independently, without extensive supervision from clients.
2. Choose a business name (and register it, if necessary).
3. Get a tax registration certificate (and a vocational license, if required for your profession).
1099 vs W-2
In contrast, a 1099 worker manages their own business operations and frequently serves multiple clients or customers. They handle their business expenses and are responsible for reporting and paying taxes on their income. Unlike traditional employees, they do not receive employment-related legal protections or benefits from those who hire them.
The IRS Form W-2 is a Wage and Tax Statement that records an employee’s earnings, benefits, and taxes withheld for a tax year. Employers must complete a W-2 for any part-time or full-time employee who earned at least $600 or had taxes withheld, regardless of the amount earned.
What is an Independent Contractor?
An independent contractor is a self-employed person or entity contracted to perform work for—or provide services to—another entity as a non-employee. The business assigns the task to the independent contractor, i.e., it is not the business that determines whether the project or job is to be done. It covers the products used, the expertise and strategies that have been introduced, and the extra labour that the independent contractor is employing. Independent contractors are required to fill out Form 1099 NEC under the Internal Revenue Service (IRS) of the US to show the income that they earn through services like putting on gigs, singing, etc.
IRS classification determining Independent Contractor
IRS taxation rules differentiate between employees and independent contractors. Independent contractors aren’t subject to payroll taxes at the time of payment. To determine whether a worker is a freelancer or an employee, companies must assess IRS classification rules, considering factors such as control, financial aspects, and the nature of the relationship.
1. Control: The level of control exerted by the employer over the worker is crucial. Employees typically work on-site, follow set schedules, and undergo specific training, and their tasks are integral to the business.
2. Financial: If the employer provides tools and supplies and controls other aspects of the worker’s business practices, they are more likely to be considered an employee. Independent contractors set their own schedules, are compensated hourly or per project, and their work isn’t central to the business.
3. Relationship: Factors such as written contracts, benefits, or exclusivity requirements suggest an employer-employee relationship. Moreover, longer-term relationships between the business and the worker lean towards an employee classification.
Independent contractor under DOL
Under the Department of Labor, independent contractors are issued certain benefits that they can avail. The Department of Labor (DOL) released a final statement that changes the criteria for classifying independent contractors. The final rule largely mirrors the DOL’s proposed rule. It requires companies to weigh a variety of economic factors to determine whether a worker is an employee or an independent contractor.
Employee under IRS
According to common-law rules, anyone who performs services for you is considered your employee if you have the authority to dictate what tasks are done and how they are completed. This holds true even if the employee is given some autonomy in their work. What matters is your right to control the details of the work process. The actual nature of the relationship, not the label assigned to it, determines the worker’s status. This applies whether the individual is employed on a full-time or part-time basis.
ABC test for Independent Contractor
According to the U.S. Department of Labor, employers must pass the ABC test to classify a worker as an independent contractor in many states. Employers are responsible for the correct categorization of workers or could face costly fines.
Under the ABC test, a worker is only an independent contractor if they meet all three parts of the test:
The worker is accessible from the control and direction of the hirer in relation to the performance of the work, both under the contract and in fact,
The worker performs work that is outside the usual course of the hirer’s business, and
The worker is customarily engaged in an independently established trade, occupation, or business of the exact nature as the work performed for the hirer.
The main objective of these laws is to protect workers’ rights and clearly distinguish between employees and independent contractors. Employers who hire workers and misclassify them as independent contractors may be open to liability if the individual is hurt on the job.
Exceptions under IRS
Statutory Employee
Under standard law rules, individuals classified as independent contractors might still be considered employees for specific employment tax purposes as statutory employees. This classification applies to individuals falling into one of four categories:
· Drivers who distribute certain goods or provide delivery services as your agent or on commission.
· Full-time life insurance sales agents primarily selling for one insurance company.
· Individuals working from home on materials or goods supplied by you, following your specifications.
· Full-time traveling or city salespersons primarily selling goods for resale or supplies for business use, working on your behalf
. These individuals must meet certain conditions outlined under Social Security and Medicare tax regulations.
Conclusion
Hiring both employees and contractors has its pros and cons. For instance, if you hire an employee, you can have more visibility into how your teams operate, but you’ll have to deal with payroll and taxation-related matters for each one of your employees. Conversely, if you hire a contractor, you may not have to worry about taxes as much, but you’ll sure have to work around the limited visibility and insight you get into the process they follow to complete a task. Regardless of the type of worker you hire, though, remember to create a rigorous contract that lists all the terms so that both parties are aware of their rights and obligations.This way, you can mitigate the risk of legal issues and ensure an optimized hiring process.