Independent Contractor vs. Employee: What You Need to Know

When your company needs new people, who should you hire? This decision can be more complex than simply finding the most qualified worker. Should you recruit an independent contractor, or hire an official employee? It’s important to understand the difference between the two, for your sake professionally, as well as to avoid tax and legal penalties.

The main difference between an independent contractor and an employee lies within the nature of the employer/worker relationship. However, the guidelines that outline these relationships vary between federal and state laws. Both the Internal Revenue Service (IRS) and Department of Labor (DOL) have different “tests” that employers can use to assist them in properly classifying and hiring workers. Here are some general principles to help distinguish independent contractors from employees.

It’s All About Control

The main difference between an independent contractor and an employee is the extent to which the employer has control over the worker. Employer control can generally be broken down into three parts:
  • Behavior Control: If the employer has the right to dictate the manner and time of a project or service, the worker is likely an employee.
  • Financial Control: If the employer has the right to control the financial/business aspects of a worker’s job (such as purchasing supplies and managing expenses), the worker is likely an employee.
  • Relationship: Additional considerations must be taken concerning the employee/worker relationship. These mainly include the permanency of the relationship and the type of service the worker provides for the business. Generally, employees enter in longer-lasting relationships with employers and provide work that is more integral to the business operations compared to independent contractors.

Other Considerations

Sometimes, the worker’s classification can remain unclear after analyzing the degree of control. These additional factors can help determine a worker’s status:
  • Does the worker receive pay based on projects and/or on some irregular basis?
  • Does the worker have other income besides this business, and the option to work freely in the market?
  • Does the worker supply his/her own materials and cover the expenses?
  • Can the worker be discharged at any time, and/or choose his/her own work times?
  • Is the work supplemental to the business (not within the integral aspects of business operations)?
If the answer is “yes” to these questions, the worker is likely classified as an independent contractor.

What Does This Mean for My Company?

In terms of your business operations and finances, the main differences occur in payment and taxes. When a worker is an employee, the employer will be responsible for paying income, Social Security, Medicare, and unemployment taxes. The employer will also likely be required to offer employee benefits, such as health insurance and sick pay. Additionally, the business must adhere to overtime and minimum wage policies.

When a worker is classified as an independent contractor, these additional expenses do not apply. The independent contractor must therefore file self-employment taxes. However, if a business wrongly classifies an employee as an independent contractor, the employer may be held liable for employment taxes and could face additional penalties. Therefore, it is important to consider the differences between independent contractors and employees proactively and continuously throughout your business operations.

These types of situations can be difficult to navigate, especially in the small business and remote world. At VForce, we can help you understand all the complicated aspects of running a small remote business. Download our A-Z Guide for remote hiring here!From distinguishing between independent contractors and employees, to helping with general remote hiring and onboarding, we have solutions for all your needs. Contact us today for a free consultation.