Difference Between An Independent Contractor And An Employee

As a business owner, it’s always a good thing when the business is going so well that you need extra help to keep up with the demand. However, one of the biggest decisions will be whether you want to hire someone as an employee of your business, or do you instead want to use individuals who are classified as independent contractors. Since there are significant differences in terms of taxes, labor laws, and much more, it is not a decision to be taken lightly. To make sure you understand the ever-changing rules regarding taxes and employee classification, here are the key differences between employees and independent contractors.

The Official Definitions

Since the last thing you want to have happen to your business is having the IRS saying you have violated various tax laws, it is best if you first understand the government's definitions of employees and independent contractors. According to the IRS, an individual is an independent contractor if a company with which they are working has the right to control or direct only the result of the work, and has no official control over how the work will be done or exactly what will be done. However, the government will consider a person to be your employee if they work directly under your control and direction and accomplish various tasks in exactly the manner you requested.

The Tax Question

As for the taxes paid by employees and independent contractors, it generally focuses on FICA. If you hire a person to be an employee, you know you are required to withhold Social Security and Medicare taxes, as well as income tax. However, should you decide to classify extra help as independent contractors, these people will not be subject to income taxes or FICA withholding, but will instead be responsible for paying their self-employment tax.

What About Termination?

As you know, every person who comes to work for your business is not always the best fit. Because of this, situations do arise where a person needs to be relieved of their job. But when it comes to termination, there are some differences regarding employees and independent contractors. For example, while many people are employed on an "at-will" basis, not every job falls under this designation. Thus, if you have a problem employee, you may be able to terminate them only if you have sufficient cause to do so, and you may also be required to give them notice. However, if you have an independent contractor who is problematic, they can usually be let go at any time and for any reason. The major exception to this will be if the IC signed a contract for a specified term of work, so keep this in mind.

Minimum Wage and Overtime 

In many businesses, overtime hours for employees can quickly put a dent in a company's profits. Because of this, you should realize major differences exist regarding wage and hour laws for employees and contractors. For anyone who is legally an employee of your business, federal and state wage and hour laws require you to pay them at least the federal minimum wage and overtime pay in certain situations. But for an IC, they are usually paid a flat fee based on the terms of a contract, and are never subject to being compensated for any hours deemed to be overtime.  

Workers' Compensation

Unfortunately, even if you have a business with an excellent safety record, accidents do eventually happen to workers on the job. From cuts and broken bones to car accidents or slipping and falling on stairs, the question of workers' compensation will always come up in such instances. If you hire someone as an employee and they do suffer a work-related accident, they are eligible to receive workers' compensation benefits. Yet if they are classified as an IC, they are not eligible for workers' compensation benefits. However, remember this may not be the end of it, since an IC could choose to file a personal injury lawsuit against you and your business.  

Know the Rules

Since the IRS is extremely picky when it comes to classifying individuals as either employees or independent contractors, always make sure you know the rules regarding taxes, wages and hours, and benefits prior to making your hiring decision. Should you make a mistake and have the IRS decide you have improperly classified a worker, you could face fines or other penalties.  

Due to employees and independent contractors often performing very similar tasks and sometimes working side-by-side within a company, it can be difficult to know which classification will work best for your business. By looking at the work that needs to be done, how your expenses will differ between an employee and IC, and other related factors, you can determine which option makes sense for your bottom line.