What Makes an Independent Contractor not an Employee?

How do you differentiate between an employee and an independent contractor? It's a seemingly obvious answer, but in some cases the separation can become difficult. The classification can significantly change the type of contract between the two parties, as well as the tax structure, the type of insurance required and the benefits the worker may be entitled to.

For employers, taxes and insurance are easier and more cost effective when hiring an independent contractor over an employee. However, if you are going to be a major contributor to the business, employee status offers greater benefits than working as an independent contractor.

What is an independent contractor?

An independent contractor is classified as an individual who is self-employed and utilizes an independent contract agreement to provide services to a client in exchange for an agreed upon fee, which may include some form of commission. The independent contractor is also responsible for end product or delivery of service, but the employer has no oversight on how the project is completed.

Since the independent contractor invoices the client separately rather than being placed on the employer's payroll, it's important to note that federal, state, and local taxes are not withheld from the payment, making the contractor responsible for staying current on all tax obligations. As a contractor, you should receive an independent contractor form, or a form 1099 from the client, which will report any earned income during the tax year to the federal government.

What classifies an employee?

An employee is an individual who is on the employer's payroll and is paid either by salary, commission, or a combination of base pay and commission. Federal, state, and local taxes are withheld from all earned income, and income is reported to the IRS by the employer on the form W-2. The employer also defines the employee's work methods and employee's are often subject to performance evaluations.

A good rule of thumb to follow is if the employer maintains the rights only to direct the end result of the work, and not the methods for obtaining it, then the worker is likely considered an independent contractor. While there are certain elements that apply to both employee and independent contractor, it is important to take a holistic approach when analyzing the business relationship rather than focusing on one or two elements. There are, however, a few factors that would typically lead courts to classify a worker as an independent contractor, including:

  • You are not required to follow specific methods or instructions for completing your work.
  • You can hire assistants to complete your job.
  • You provide services or products to several other businesses.
  • Your services or products are available to the general public.
  • You have a written contract between you and the employer outlining each of your rights and responsibilities.
  • The business relationship is often short term.
  • You are not paid in a traditional manner, such as bi-weekly. There are, however, exceptions to this rule and other factors will have to be weighted.
  • You are making investments into facilities or equipment to complete your tasks and have exposure to profit or risk of loss.
  • You sign an independent contractor agreement or receive an independent contractor form for tax reporting. However, if the employer does not supply this form, be sure to have a 1099 contract template on hand.

Courts also use a set of standards when determining the status of an employee, these typically include:

  • You are required to follow specific methods or instructions for completing your work.
  • You are required to work a set amount of hours and days each week.
  • Your employer supplies the office, equipment, and tools needed to complete your work.
  • You receive performance training from the employer for completing assignments.
  • The work assigned to you is part of everyday business of the organization.
  • The business relationship is long term.
  • The employer often assigns additional projects.
  • You are paid in a traditional manner, such as bi-weekly. There are, however, exceptions to this rule and other factors will have to be weighted.
  • You or your employer has the ability to terminate the business relationship.

These are a few fundamental differences between employees and independent contractor, but if there is ever a question you should consult your local government or a professional. If you are working as an independent contractor, keep in mind you are responsible for tax reporting and payment, if an employer doesn't supply a 1099 form, you should have one on hand. These are easy to acquire from businesses that specialize in creating 1099 contract templates.

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