Employee versus Contractor: What’s the difference?
As your small business grows, you will need additional help to get things done. Since you can’t continue to wear all the hats all the time and hope to maintain quality products or services, you need to hire someone. What that someone looks like can vary by need or work type, but the IRS has specific rules regarding employees, contractors, and independent contractors. If you pick the wrong classification, there can be HUGE penalties.
According to the IRS, the level of control and independence fall into three categories behavioral, financial, and type of relationship. These three factors determine whether a person is an employee or contractor.
Behavioral: Does the company controls what the worker does and how they do their job?
Financial: Does the payer control the money aspects? Do they determine when the worker is paid, what expenses are reimbursed, and who supplies tools or equipment?
Relationship: Does the worker have a contract, benefits, insurance, and vacation pay? Is it continuous work that is performed? Is it an essential aspect of your business?
Basically, an employee is on the company’s payroll and receives benefits. There is an expectation of rule-following and loyalty. Employees are onboarded and have company-provided training. The company pays for their expenses and travel, and they typically work at a company’s location using company equipment. However, some employees may work remotely using company resources.
An independent contractor is an independent worker who is autonomous, determines their work hours, receives no company benefits, and is responsible for their own taxes, insurance, etc. The company does not pay for their travel and other expenses. There is a different onboarding process, and work may be completed remotely using their own equipment. The work can be short or long-term, but the worker is usually contracted for a unique skill set.
Some contractors are employed by a third party to work onsite at another company. In this case, the third party is responsible for the contractor’s wage, taxes, etc. This type of relationship is called a W-2 contractor and is often used by temporary staff agencies or technology firms.
There are consequences if you misclassify an employee as a contractor. Your company can be held responsible for unpaid wages, overtime, workers’ compensation, retirement contributions, benefits, Social Security and Medicare contributions, unemployment insurance, and more. In some instances, there are state and federal penalties.
At least 25% of workers are misclassified as independent contractors when they shouldn’t be. Simply put, it is not worth the risk. Even large companies like Microsoft have been caught misclassifying their contractors and had to pay large sums of money to settle the issue.
Where Microsoft went wrong is that they expected their independent workers to work alongside employees. Microsoft employees and contractors had the same supervisors and jobs with specific hours of employment. They treated their contractors like employees without benefits.
For temporary or project-based assignments, an independent contractor who possesses the skills you need is the way to go. However, if you are looking for someone who can work a specific set of hours, is part of a team, and a permanent, integral part of your business, a part-time or full-time employee would work best for your situation.
If you have any questions regarding how to classify your employee, please feel free to contact me.
Sources:
https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
https://www.businessnewsdaily.com/770-contract-vs-employees-what-you-need-to-know.html
https://gusto.com/blog/hiring/independent-contractor-vs-employee
https://work.themomproject.com/resources/small-business-bootcamp-employee-contractor-independent-contractor
https://www.reuters.com/article/businesspropicks-us-findlaw-dont-treat-c/dont-treat-contractors-like-employees-idUSTRE53063S20090401
