BooksTime  ➞  Articles  ➞  Independent Contractor vs Employee: What Employers Need to Know

March 22, 2023

Independent Contractor vs Employee: What Employers Need to Know

Reading Time 7 mins

If you recruit a new specialist, you must correctly choose the status between independent contractor vs. employee. Let’s discuss the dissimilarities between these professionals and why comprehending the specifics of collaborating with them is critical. Mistakes in identifying can become a severe problem for workers, as they may lose legal protection and well-deserved benefits. Incorrect classification is also problematic for entrepreneurs, resulting in sanctions and litigation.

Some words about employee

Whole-time employees are people hired by a firm to perform one or more roles. These proficients can count on statutory benefits of W-2 workers.

An employee is a human who works permanently for one or more firms. All employment conditions are described in the separate agreement. A contract may be concluded orally or in writing, directly or indirectly. Enterprises have absolute control over their staff: what they do, how they perform their duties, and at what time.

An enterprise tries to find staff for particular positions with clearly defined liabilities. Salaries depend on their qualifications, practice, knowledge, and productivity.

Some words about a contractor

An independent contractor (freelancer, outworker) is a business owner or professional hired by an organization to perform specific objectives and responsibilities. Such a specialist demands reward for the services and offers the customer his skills, instruments and machines. Professionals independently track the payment of personal and employer taxes. The freelancer can act as a bookkeeper, designer, IT expert, or another skilled worker, offering services to organizations, customers, or third parties on behalf of the client. All financial settlements take place on a freelance basis. Consider other features of such labor market participants:

  • Contractors work independently; the organization does not recruit them. They can simultaneously interact with a different number of firms.
  • These professionals voice the cost of services, while their clients do not withhold taxes on these amounts since professionals pay taxes on self-employment.

Hirers control the results of contractors’ work but not the process. These professionals can act in a way that suits them without being influenced by clients. Freelancers are solely responsible for the achievements of their activities.

Independent Contractor vs Employee: What Employers Need to Know

No More Bookkeeping Stress

Keeping proper financial records is time-intensive and small mistakes can be costly. BooksTime makes sure your numbers are 100% accurate so you can focus on growing your business.

Сlassification tests to determine the worker status

Various state agencies have composed algorithms to identify a status independent contractor vs. employee; each concentrates on the elements of the activity. Most of the test criteria are similar, although some positions contradict each other. Let’s look at the most famous staff classification options.

US Department of Labor (DOL) test

On October 3, 2022, DOL submitted a Notice of Proposed Rulemaking. The basic aim of such a paper is to facilitate the determination and classification of whether an agent is an employee or a contractor following current law. The updated directive proposes to eliminate the «economic reality test» and utilize instead a «totality of the circumstances» estimation, which includes the study of the next details:

  • Possibility for professionals to make revenue and lesion depending on their qualifications.
  • The total investment of each participant of the treaty.
  • The degree of constancy and duration of the relationship.
  • The features of the customer’s control over the performer.
  • The extent to which the job performance is vital to the hirer’s business.
  • The level of attainments demanded to accomplish the project.

Changing classification standards may force some enterprises to reconsider the position of the professionals they collaborate with. Additionally, employers may have some outworkers already considered employees under recent directives.

IRS test

Logically, the IRS is interested in the tax base. Employers must withhold income tax, social security fees, health insurance payments, and unemployment charges from employees’ earnings. All these payments are irrelevant when we speak about outworkers since they deal with other types of mandatory fees. Let’s consider several critical aspects that, according to the IRS, must be regarded when classifying personnel.

First one is the level of control. If the firm’s management keeps track of what job is being done and handles it, this is called behavioral control. When a business observes financial manipulations in the work of personnel, it provides financial control. An agent is generally identified as an independent contractor if he:

  • invests significant sums in its activities,
  • does not expect to be reimbursed to get business spending,
  • receives revenue or loss from its activities.

If all these aspects are present in a professional’s work, he runs a personal business. The DOL often treats self-employed professionals as contractors.

The second aspect is the features of the relationship. If the control factors seem too vague to you, analyze the character of the cooperation between professionals and enterprise:

  • Outworkers are not entitled to health insurance, paid holidays, or other social benefits.
  • Terms of any employment contract between an enterprise and a professional should give an accurate idea of the specifics of their cooperation.

When studying the above factors, you should comprehend that the IRS does not analyze a single characteristic; however, one criterion may be enough to mark a specialist as an employee. There is no approved number of factors that define the specialist position.

Principal dissimilarities between outworkers and employee

Misclassification is one of the basic risks when interacting with freelancers. If you make the slightest inaccuracy, your business can be sued. World-renowned corporations such as Google, Uber, and Lyft have regularly faced lawsuits recently due to the misidentification of personnel. Depending on the enterprise scale and the number of misclassified agents, the expenses of damages may be enormous. The table summarizes some of the distinctions between the two classes of counterparties.

Employees Independent contractors
Employment position Most often, they deal with one customer or company. Cooperate with many enterprises.
Hiring purposes An agent’s checklist of duties may change, but they are required to demonstrate some loyalty to the enterprise. They are recruited to solve specific problems.
Training and development Go through a long stage of adaptation and learning. Specialists don’t have to go through special training programs. They develop skills and get knowledge by themselves.
Pay and taxation Employees receive a wage from their employer, and the organization also withholds from their earnings. Independently track the computations of mandatory payments. They get rewards for non-standard objectives and are not on the organization’s staff.
Tax reporting directives Inform about all funds paid to an agent during the year on form W-2. Inform about payments of $600 and more on form 1099.
Level of Independence Employees must strictly adhere to instructions and be available at certain times specified in the schedule. They make their schedules to cooperate with several companies.
Instruments and machines The customer offers instruments and equipment and is responsible for renovation, maintenance, and assurance spending. As a rule, freelancers own all the common instruments and equipment. They also cover renovation, maintenance, and assurance spending.

Sometimes an employment contract balances between an employee and an outworker. If you are in this situation and don’t know which interaction to apply, you may fill out Form SS-8 and let the IRS come to a decision. An enterprise or an agent can submit such a document. The IRS will examine all the insights and conditions and issue a formal opinion on the status of a professional.

Remember, the authorized body only sometimes processes applications quickly, and waiting for a decision may take several weeks. To speed up the process, you should seek the assistance of a tax or labor lawyer. They are ready to advise on the personnel classification and the contractors’ identification.

Independent Contractor vs Employee: What Employers Need to Know

How to select an optimal counterparty

There is no single answer to the question of whom to choose: an independent contractor vs. employee; it all depends on your organization’s needs. You may need to use both kinds of workers at different times. To comprehend which is better to hire, let’s look at the advantages and disadvantages of each variant.

Pros and cons of cooperation with an employee

Hiring a specialist means that you may train him to follow the request and accept values of the enterprise. Such agents tend to stay with the enterprise for a long time, so you don’t have to explain all the processes from scratch every time you start a new project. Consider other profits of the recruiting:

  • Planning projects is simpler because you have control over how the operation is done and when it will be completed.
  • Lower hourly rate, although you must pay frequent taxes and benefits.

Since agents are on your payroll, you must pay them until they retire or until you fire them. Even if your organization is going through a difficult period, you must allocate funds to pay wages.

Pros and cons of cooperation with a contractor

These professionals often specialize in a narrow niche and have unique skills, so you can find a freelancer ready to complete the whole objective from start to finish. Because they work at their own pace, you don’t have to track what the professionals do. Other profits of the interaction:

  • More straightforward to scale – you have a chance to start and finish contracts anytime.
  • No need to track benefits, pay overtime and withhold taxes from counterparties.

If we speak about the disadvantages of agreements with contractors, the company’s management must be prepared to reduce control over performance. Besides, professionals often charge more than employees because they cover their taxes independently.

Final words

Collaboration with agents in the staff and freelancers has positive and negative moments. Recruiting a professional will make tracking the department’s activities more accessible, but simultaneously, you must interact with payroll and reports issues. These categories of financial operations can be outsourced to the company BooksTime. Qualified accountants will help prepare reports and monitor the correctness of settlements with each counterparty.

When interacting with an outworker, you can eliminate headaches with mandatory fees. Still, you must put up with limited control and understanding of completing tasks.

Whatever option of cooperation with specialists you choose, it is critical to draw up a precise treaty that will include the rights and liabilities of each party. It cuts the risk of legal sanctions and streamlines the recruiting process.

Share This Article

Rate the article
Rate the article
(0 voted) 0 / 5

Author: Charles Lutwidge

Read previous article
Read the next article

Talk To A Bookkeeping Expert

A bookkeeping expert will contact you during business hours to discuss your needs.