Employment law behaves differently for each employee type, and so does pay. The worker types also affect the tax the company or business pays and the tax that the worker pays. For an employee, an employer has to pay Medicare and social burdens and unemployment tax in the wages that are paid.
But for independent contractors, the employers don’t have to do that. But in order to manage their books and taxes, employers must have a clear idea of the distinction between the two.
The difference between independent contractors and employees can save company expenses. A 1099 worker means hiring an independent contractor, and employing a W2 worker means hiring a permanent employee.
If a business hires an independent contractor, then the company can save on costs and legal requirements. The tax forms used for an independent contractor are the 1099 MISC, which is given to them by the company. For an employee, a W2 is filed by the company.
- Independent contractor
This person is actually self-employed and is contracted to perform a specific job. They may use their own tools and set their own tasks. They can also work for more than one business. As they are self-employed, Companies don’t deduct tax at source from their paychecks. They pay their own taxes and have to pay for their own benefits. A 1099-MISC is used for reporting payments that are made to the independent contractors.
An employee is hired by a Company via an employee agreement. Companies withhold taxes from their salaries. They train them, provide benefits, and also train them. Companies have more control over their employees, and the work can be dictated to them. A W-2 is used for employees for whom the employer pays taxes.
How to determine who is an employee and who is an independent contractor?
There isn’t a black and white test that determines if a worker is an employee or an independent contractor. However, the IRS takes into account three categories of control that a company has over a worker to determine if that worker is an employee or an independent contractor as control is the one factor that differentiates an independent contractor from an employee.
- Financial – If the aspects of the business are controlled by the party that pays. (Supplies provider, how the worker is paid, if expenses are reimbursed)
- Behavioral – Does the company have the right to control or does control the tasks performed by the worker or how the tasks are done.
- Relationship type – The tasks performed by the worker are key or not? Is the relation between the worker and company permanent? If there are employer-type benefits like vacation, 401K, insurance, or if there are written contracts?
There are both advantages and disadvantages of hiring contractors or employees. The benefits are as follows:
Benefits of the Independent Contractor
- Independence and flexibility – A contractor can be hired for one or more projects and have to be paid only for those. Unlike an employee, there isn’t any obligation to continue payments when there isn’t any work. This gives a lot of flexibility to companies to hire on an on-need basis.
- Expertise – This is one of the most important benefits of having an independent contractor in a company. If the project requires specific expertise and design, then companies can hire contractors till the project lasts, and the can let them go. Usually, people with such high expertise are expensive, and having them on a continuous payroll may be too expensive.
- Low cost – Cost is a big factor why companies hire contractors. There isn’t any minimum wage compliance, nor are benefits needed to be paid. As companies don’t pay a contractor’s taxes, there isn’t much paperwork to do.
- Legal risk – As contractors aren’t covered under the worker’s compensation, they cannot bring forth claims of wrongful termination, which lowers the company’s exposure.
Benefits of an Employee
- Training – Employees will be there with the company for long, so training them once is needed and is an investment that will pay good returns.
- Continuity – Employees are with the company for the long haul and can lend a hand no matter what the task.
- Owner’s time – Employees free up the owner’s time to concentrate on more important tasks. Tasks can be delegated to them as they are around for longer.
- Commitment – Employees are committed to their employers if they are treated right. Which means the company gets better work and more dedication.
Bothe employee types have their own pros and cons. But both are needed to perform certain tasks in any business.