Employee vs. Independent Contractor: What is the difference?
The question of classifying someone as an employee or contractor is more complex than you think. If you are an employer and you incorrectly classify someone, it can cost you a great deal of money and even more headaches.
The benefits to the employer in classifying a worker as a contractor are obvious:
- No need to worry about paying half of the FICA and Medicare withholding
- No need to pay any additional benefits that you may otherwise be required by law to pay certain employees (such as insurance, sick time, vacation time, retirement, 401K, etc...)
- Independent contractors don't count as employees for determining whether you are required to carry worker's comp. insurance.
You can see why an employer would be naturally inclined to want to classify EVERYONE he hires as a contractor.
Employees vs. independent contractors
In general an employee works for a particular organization and that company has the authority to dictate what that employee does and the manner in which he/she must do it. An independent contractor, on the other hand, is a person that the employer hires for services and only pays for the results of the labor. The employer, or contracting party, does not manage or direct the manner in which the work gets done.
Factors for determining employee or contractor status
This sounds simple in theory, but it can be quite complicated in reality. There are many examples of potential jobs where answering the question may be difficult. For this article, I will list and explain the IRS's 20 factor test which it uses to determine whether any given worker should be classified as a contractor or an employee.
- Instructions: employees comply with instructions about when, where and how their work is to be performed, whereas contractors set their own hours and do the job their own way.
- Training: employees are trained to perform in a certain way, the way the employer wants it done. Contractors use their own methods and receive no training from the employer who is purchasing their services.
- Integration: the services of an employee are merged into the business and the business is dependant on these services in order to continue to exist. The life of the business is not dependant on the services of a contractor.
- Services rendered personally: the employee is the person who actually does the work, whereas a contractor can assign his or her own workers to do the job.
- Hiring, training, and paying assistants: an employee hires, trains and supervises other workers only at the direction of the employer. Contractors, however, hire, supervise and pay their own workers and must also provide materials and labor to do the job.
- Continuing relationship: an employee continues to work for the employer until he quits or is fired. A contractor does a job and when the job is done, so is the contract.
- Set hours of work: employees must adhere to the employer-imposed schedule. Contractors set their own schedule.
- Full time required: employees normally work full-time whereas contractors work when and for whom they please.
- Doing work on employer premises: employees work on the employer site or on a route or premises designated by the employer. Contractors work at the employer site, but also work at their own site.
- Order of sequence set: employees perform tasks in the sequence designated by their employer. Contractors work at their own pace.
- Oral and written reports: employees must submit these, contractors have no such requirements.
- Payment by hour, week or month: employees get paid regular amounts in set intervals, whereas contractors get paid either straight comission or on a per-job basis.
- Payment of business and/or travelling expenses: employees are normally reimbursed for these whereas contractors pay these out of their own pocket.
- Furnishing of tools and materials: employees are furnished tools whereas contractors have their own.
- Significant investment: an employer invests time and money to train an employee. No such investment is needed with a contractor.
- Realization of profit or loss: employees cannot realize a profit or loss with their decisions. A contractor's decision can affect his/her bottom line.
- Working for more than one firm at a time: employees normally can't do it, but contractors can.
- Making service available to general public: employees can't do it, contractors can.
- Right to discharge: employee can be fired at any time. Contractor can't be fired as long as he/she is performing in accordance with the applicable contract.
- Right to terminate: employees can quit at any job. Contractors may be subject to civil liability if they quit in the middle of a job.