Difference Between Independent Contractor and Employee
As outsourcing continues to soar in popularity, the lines between contractors and employees are blurring which consequently has stimulated an upsurge of employee misclassification cases.
Misclassifying an employee as an independent contractor can be catastrophic for an organization, it is important to be aware of the differences in order to limit your risks of a lawsuit over non-compliance.
What is an independent contractor?
An independent contractor (IC) is self-employed and provides services to another business. They hold the responsibility to declare their income and submit self-employment taxes to the IRS.
What is an employee?
An employee is an individual who works directly for a company that dictates their workload and in return receives a set annual salary or an hourly wage.
What are the differences between an independent contractor and an employee?
The work performed
Employee - If they work a set amount of hours each week dictated by the employer they are likely an employee.
Independent Contractor - If a worker can set their own work hours and work with little direction and contact from a company.
2. The way they are paid
How a worker is paid is one of the main ways to distinguish an IC from an employee.
Employee - An employee is paid on an hourly or salary basis which is subject to payroll taxes and may have the option to work overtime. Employers withhold their income tax and social security from their pay and must file Form W-2.
Independent Contractor - ICs are paid for projects they complete for companies and determine their own work schedule. As a result, the IRS considers them to be self-employed, which means they have to pay their own self-employment tax quarterly. If you pay an IC over $600 during the tax year, you must send them a 1099-NEC form.
3. The relationship with the company
The relationship between a worker and a company determines how they are classified.
Access to benefits - If a worker has access to company benefits and health insurance, they are likely an employee. An IC is not eligible for benefits and unemployment insurance.
Length of contract - When determining whether a worker is an IC or an employee, the IRS factors in the length of your relationship with them. If they are working for your company on a long term basis, they are an employee.
IC's usually work on a short term basis to complete set projects. The IRS may view a worker as an employee if the service they provide directly relates to your business' core work.
Why is it important to know the difference between an employee and an independent contractor?
You must be aware of the differences as it determines the way you pay them in terms of whether payroll taxes are withheld from a worker’s personal payment. If you engage an independent contractor you don't withhold taxes from their payment, if they are an employee you must withhold these taxes.
If the IRS investigates your business and discovers you have been misclassifying an employee as an IC, this goes against employment law. The business will have to pay back taxes and may also face penalties for income taxes, medicare, social security, and unemployment taxes.
Businesses must be extra cautious in their processes as the risk of employee misclassification has increased due to the extortionate number of workers being made redundant due to COVID-19. In response to this, the government enacted The CARES Act which for the first time ever, made unemployment available to ICs should the states they are operating in wish to enact it.
As a result, an influx of ICs came forward believing they’re eligible for unemployment. The government will most likely build up a list of these ICs and attempt to recoup these costs, meaning they will probably investigate whether workers were classified correctly. This could strengthen claims for misclassification.
Key takeaway - Determine the status of your worker to remain complaint
You must determine the status of your worker to ensure you remain 100% compliant. If you are ever subject to an audit and are found to be misclassifying your workers, the IRS may seek to recoup these costs and risk being subject to fines.
If you are unsure what to classify your workers as you can file a Form SS-8 to the IRS to request a determination. Get in touch if you have any questions regarding engaging employees and independent contractors compliantly.