Insight

Employee vs. Contractor: What’s the Difference? (And Which One Comes to the Holiday Party?)

In Part I of this series, we look at the differences between employees and contractors. In Part II, we’ll investigate the pros and cons of each and determine which hire is right for you.

Employee vs. Contractor: It’s All About Control

Generally, the question of whether someone qualifies as an employee or an independent contractor comes down to the issue of control. Many government agencies, including the IRS, use the “right of control” test to determine if a worker should be classified as an employee or a contractor.

What is an employee?

If an employer has the right to direct and control the way a worker performs, that worker is an employee. In an employee relationship, the employer typically dictates not only the results of the job but also when, where, and how the employee does the job. If you, as an employer, have the right to tell a worker both what to do and how to do it, then that worker is an employee.

What is a Contractor?

An independent contractor works on a contract-by-contract basis for individual clients. Contractors own their own business or are contracted out by staffing agencies to work on long- or short-term projects. They work free of supervision, direction, and control from the business that hired them and can work for more than one company at a time.

Contractors often:

  • Carry their insurance.
  • Provide their tools and equipment.
  • Pay their expenses.
  • Set their schedule.
  • Hire their help or subcontract work out to others.

In general, if you, as the employer, determine the results of the work, but the person you’ve hired determines how the work is completed, you’ve hired a contractor. The key is in the degree of supervision, direction, and control you maintain over the worker.

When is a contractor the right hire for you?

You might want to hire a contractor if:

  • Your project is short or of limited duration.
  • Specialized knowledge or experience is needed for a specific task.
  • You need to quickly recruit talent for a contract with a short turnaround time.
  • Special circumstances arise (such as when a deadline is looming, and an employee is out sick or on leave).

The IRS: It’s All About the Taxes

Even if you’ve determined you hired a contractor and not an employee, come tax time, what matters is what the IRS thinks you hired.

Why is this important?

Because if you misclassify an employee as an independent contractor, you may have to pay substantial back taxes, fines, and penalties.

Generally, an employer must:

  • Withhold income taxes on wages paid to an employee.
  • Withhold Social Security and Medicare taxes on wages paid to an employee.
  • Pay Social Security and Medicare taxes on wages paid to an employee.
  • Pay unemployment taxes on wages paid to an employee.

But

You do not have to withhold or pay any taxes on payments to a contractor because a contractor is responsible for paying their taxes.

So, how does the IRS decide who’s an employee and who’s a contractor?

According to the IRS website, the determining factors are not set in stone but generally fall under the categories of Behavioral Control, Financial Control, and Relationship. These categories involve:

  • Autonomy. A worker is often considered an employee if you stipulate the time, place, and way that work gets done and provide the training and tools for how to do it. A worker is often considered a contractor if they choose the time, place, and way that work gets done and depend on their expertise and equipment to carry it out.
  • Compensation. A worker is often considered an employee if you pay them a guaranteed wage with the expectation that the relationship will continue indefinitely, and you reimburse them for expenses. A worker is often considered a contractor if you pay them for only a specific project or period and do not reimburse them for expenses.
  • Perks. A worker is often considered an employee if you provide them with benefits such as insurance, retirement, vacation time, and sick leave. A worker is often considered a contractor if you don’t provide them with benefits.

So, there you have it. It’s all about control. And taxes.

But which one comes to the holiday party?

In general, an employee comes to the holiday party.

But you can invite anyone you want.

Cheers!

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