Difference Between Employee and Contractor: Everything You Need to Know
The difference between employee and contractor comes down to the nature of the work that the worker is asked to complete.8 min read
2. What Is an Independent Contractor?
3. What Is an Employee?
4. Considerations When Identifying Someone as an Independent Contractor
5. Considerations When Identifying Someone as an Employee
6. Employer Tax Liability
7. What to Know About Job Misclassification
Difference Between Employee and Contractor
The difference between employee and contractor comes down to the nature of the work that the worker is asked to complete, including whether they have to provide their own equipment, the consistency of the work, and where the work is being completed.
What Is an Independent Contractor?
With online jobs and temporary work gaining in popularity, the global economy has seen a dramatic rise in independent contractors. An independent contractor is not the same thing as an employee. The rules governing employers when it comes to hiring independent contractors fall under the U.S. Fair Labor Standards Act. This piece of legislation outlines the circumstances in which a worker would be considered an independent contractor as opposed to an employee. This affects everything from taxes to wages, medical benefits, and saving for retirement.
For the employer, there are certain advantages that come with hiring independent contractors rather than employees. The employer is under no obligation to provide medical benefits for the contractor, and that worker is forced to find insurance on their own. The contractor does not have the option of joining a labor union at the company. Local, state, and federal taxes will not be deducted from the contractor’s paychecks.
The U.S. Fair Labor Standards Act looks at a variety of factors when deciding what constitutes an independent contractor and an employee. If the employer has little to no control over the finished product or service, but rather simply provides goods and services to a client, some of the company’s workers will likely be categorized as independent contractors. If the worker does not receive a steady paycheck or a salary, they are more likely to be an independent contractor. If the business depends heavily on one of its workers, that person is more likely to be an employee and not an independent contractor. If the worker is considered easily replaceable and their work requires specialized skills, that person is probably an independent contractor.
What Is an Employee?
A company will hire an employee to fulfill a specific role and perform a certain task. An employee typically works regular hours and receives regular paychecks with automatic deductions for state and federal taxes. If the person working for the company depends on their job for a majority of their personal income, they will most likely be considered an employee. The company that hired the employee usually has more control over the finished product, rather than constantly adjusting their goods and services for a particular client.
Considerations When Identifying Someone as an Independent Contractor
If a company is struggling to determine if a worker should be an employee or an independent contractor, the employer should consider several different factors. If the company is hiring someone with the expectation that the person will supply their own equipment, the worker should be compensated as an independent contractor. Any instance in which the company does not supply its workers with all the equipment necessary to perform the basic duties and responsibilities of the job, the workers will be considered independent contractors.
Some jobs come with a great deal of flexibility such as those that require performing duties for a limited amount of time, the worker will be an independent contractor. This person might have the freedom to accept work at the company as often or as infrequently as they please. The worker is also free to quit the job at any time without fear of retribution or seriously interrupting the business’s daily operations. If a worker is a free to decide when and where they complete their work such as during odd hours, at home or at a café, they are usually considered an independent contractor.
Deciding whether a person is an employee or an independent contractor usually comes down to the type of work being performed. If the work being performed by the worker is not an integral part of the company’s overall structure, that person is probably an independent contractor. Independent contractors also tend to provide their services to more than one company, such as a consultant with several different clients. This also usually means that the worker does not depend on one company for the bulk of their income.
- Tend to work where and as often as they please.
- They might have their own office that’s not connected to the employer such as a co-working space or an at-home office.
- This person also works for the most part on their own, without relying on constant feedback or oversight.
- If an employer is not satisfied with the contractor’s work, they will simply end the contract.
- The employer is not responsible for providing the worker with detailed instructions in terms of how to complete the work. Instead, the independent contractor is free complete the task however they see fit.
Unlike a traditional employee, an independent contractor will not see taxes deducted from their paychecks. They are not subject to Federal Insurance Contributions Act (FICA) withholding and must pay taxes on their personal income using what’s known as self-employment tax. This person will usually have to monitor their income at the end of the year and pay local, state, and federal taxes in bulk. This usually requires some budgeting and financial planning on the part of the contractor.
An independent contractor cannot receive unemployment benefits if they lose one of their jobs. They are also not eligible for workers' compensation. That means that if the worker were unexpectedly let go from the company, they cannot collect unemployment from the federal government. Independent contractors also do not receive overtime for working long hours. They are simply required to complete the task or assignment on time at the mutually agreed upon rate.
Independent contractors are not protected by fair labor laws such as anti-discrimination laws and workplace safety laws. Most of the time, an independent contractor will work at home or at an office separate from the company. Thus the company is not responsible for providing the worker with a safe working environment.
When a company hires an independent contractor, they usually do not provide the worker with any specialized training. The contractor should come to the table knowing how to complete the task at hand. An independent contractor usually specializes in one skill or service.
Considerations When Identifying Someone as an Employee
- Usually have a great deal of consistency on a day-to-day basis.
- They usually work for one employer, rather than working for multiple companies at the same time.
- They also usually work from the same location such as an office at the company. This means that the employer needs to follow the country’s labor laws including anti-discrimination and workplace safety laws. The employee will come to work at the company expecting to be treated fairly, regardless of their race, gender, or sexual orientation. The employee also depends on the company for a safe working environment. If the employer is in violation of any of the county’s labor laws, the employee is free to file a complaint or a lawsuit.
- The employer is responsible for creating a set schedule for the employee including their hourly or yearly rate of pay.
- The employee can expect to receive some medical benefits from the company if they are considered a full-time employee.
- They can also collect workers’ compensation if they get injured on the job, as well as unemployment benefits if they are fired by the company unexpectedly.
The employer also has a great deal of say in terms of how the employee completes their work. This usually comes with an in-depth employee manual that outlines the company’s expectations for all its employees. The company can tell an employee how to dress and act while they are on the job.
An employee should not be responsible for supplying their own equipment such as a laptop, smartphone, or an office. The company should provide the employee with everything that they will need to complete the basic duties and responsibilities of the job. The employee should be under no obligation to invest their own money in the company, or be made to incur expenses with their own money in order to continue working at the company.
While an employee needs to have some basic credentials and qualifications, the company will usually supplement their knowledge or experience by providing on-the-job training. This gives the company more oversight in terms of how the employee completes their work. If an employee fails to work in the manner outlined by the company, it will usually lead to the employee’s eventual termination.
Employees are subject of FICA withholdings and should see a sizable portion of their regular paychecks go to local, state, and federal taxes, including social services such as Medicare, Medicaid, and Social Security. The employee is also free to join a labor union at the company if the option exists. An employee can also expect to receive a higher rate of pay if they are forced to work long hours beyond their normal schedule.
Employer Tax Liability
All employers must deal with what’s known as employer tax liability when they hire employees. This means that the company or employer must pay state and federal taxes on behalf of the employee. If the employer hires independent contractors instead of employees, the employer does not have to pay taxes on behalf of the employee, but rather simply pays the contractor their hourly rate in full.
Understanding the differences between employees and independent contractors is a vital part of running or creating a business. If the employer wrongly categorizes one of their workers as an independent contractor when they should be recognized as an employee, they might have to pay back taxes on behalf of their current or former workers that are or were eligible for FICA withholdings.
Some companies can escape the penalties incurred by wrongly categorizing an employee. What are known as safe harbor rules exist precisely for this reason. A company can continue treating a worker as an independent contractor, even though they should be treated as an employee if the company has a history of hiring similar workers as independent contractors rather than employees, or if the company was previously audited and the IRS decided that no back taxes needed to be paid.
What to Know About Job Misclassification
There are certain things that everyone should know about job misclassification in terms of how and why it happens in the first place. A company or an employee might decide to classify a worker as an independent contractor, even though the worker should be classified as an employee, so that the company does not have to pay the worker additional benefits, including medical benefits or overtime. The company might also want to avoid having to pay state and federal taxes on behalf of the worker for a variety of reasons. The employer also wouldn’t have to worry about providing a safe working environment for the worker or comply with anti-discrimination laws.
A worker may take a job that’s been misclassified for many reasons. If the person is desperate for work, they may not care about the nature of the job itself. They may also want to work for a company that they respect without worrying about issues like fair compensation or anti-discrimination laws. In many cases, the worker simply does not realize the job they have has been misclassified. That’s why it’s important that everyone educate themselves on the differences between employees and independent contractors so that they can make an informed decision when it comes to where and how to make a living.
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