Making the distinction: Employee versus independent contractor

Tuesday, August 23rd, 2011 By

Taxes

The biggest job of independent contractors is paying their own taxes. Image: Flickr / Images_of_Money / CC-BY

The growth of jobs during the economic recovery has been anemic. Many businesses are choosing to hire independent contractors to fill gaps. Before you sign on as an independent contractor, it is important to understand the differences between getting hired as an independent contractor rather than an employee.

The financial difference

For individuals, the differences in working as an employee and working as an independent contractor mostly involve paperwork and personal responsibility. When you are an employee, the employer is responsible for paying part of your payroll taxes. An employer also has more say about work hours, work process and is responsible for providing the tools to get a job done. An independent contractor is responsible for paying all of their employment taxes and has more individual control over their work process. Independent contractors are usually paid more for their work but are responsible for paying out more as well.

The way the IRS differentiates

Beyond the personal and day-to-day differences in working as an independent contractor and an employee, the Internal Revenue Service also makes a strong differentiation. There are three major questions the IRS will ask when determining if someone is an independent contractor:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

The IRS does not have a specific formula when determining employment status, it but does take these three factors into consideration.

IRS narrows classification criteria

Businesses and individuals do not always understand the classification of employees versus independent contractors correct. The IRS can determine that an individual is incorrectly classified and levy retroactive taxes on that business. Section 503, however, allows a business to maintain independent contractor classifications if certain criteria are met. This narrowed criteria affects an individual mostly in the decision to work as an independent contractor or employee. If you are offered an independent contractor position, make sure to set aside the cash for taxes and pay your taxes fully and on time. If you suspect that you would be more properly classified as an employee, discuss it with the individual in charge of your contract as soon as possible.

Sources

MoneyManagement.com.au
Forbes
IRS

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