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Employee vs. Independent Contractor – What is the Difference?

Employee vs. Independent Contractor

What is the difference?

Misclassifying an employee as an independent contractor can result in costly consequences that can be detrimental to your business. As the employer, you may become liable for the payment of taxes; including federal income tax, social security tax, Medicare tax, federal unemployment tax and state unemployment tax.

Certain factors will define a worker as an employee or as an independent contractor.

The IRS determines employee and independent contractor status based on the following three, broad categories:

  • The relationship between the employer and the worker.
  • The compensation structure.
  • The level of control the employer has over the worker.

A simple rule of thumb would be as follows:

  • Employees (sometimes called common law employees) are individuals who work for an employer that controls the work of the employee—what will be done and how it will be done. The individual is hired into your organization on a permanent basis and is subsequently paid periodically through the main payroll system. That means you’re also expected to deduct various obligatory amounts from their gross pay every single time you remit their compensation—for example, payroll and social security taxes.
  • An independent contractor is an individual who performs services for you, but you control only the result of the work. Independent contractors, are basically third-party entities that you engage on temporary terms, without absorbing them into the company’s workforce and are ultimately paid without deductions.

Independent contractors typically sign contractor agreements, while employees sign standard employment contracts.

If you hire an independent contractor and pay him/her more than $600, you must issue a Form 1099-MISC per the Internal Revenue Service. A Form 1099-MISC is IRS proof of how much you paid the independent contractor for work performed for your company. A Form 1099-MISC is to independent contractors what the Form W-2 is to employees. Failure to issue a 1099-MISC by the IRS deadline, which is usually in mid to late February, may result in penalties. 

In addition, don’t forget to obtain a signed Form W-9 from those vendors to whom you pay for services rendered. Businesses use IRS Form W-9 to request Taxpayer identification Numbers and Certifications. This would include any individuals, or un-incorporated businesses. Services rendered can include, but are not limited to: subcontracting work, building maintenance/repair, lawn maintenance/landscaping, computer services and legal services. Landlords are also required to receive a Form 1099-MISC at the end of the year, so be sure to obtain a signed Form W-9 for them as well.

If you have any questions or are unsure about whether or not an individual should be classified as an employee or an independent contractor, please don’t hesitate to reach out to us.