As your team grows, knowing how employees and contractors are defined is one key step to master if you want to make everything flourish. Although it may not seem important for your day-to-day operations, the distinction is actually quite significant for both your protection and that of your employees. This simple little label can have a big impact on you and your team’s benefits, pay schedule, taxes, and so much more.
In this article, we’ll walk you through everything you need to know about the difference between employees and independent contractors. Seems pretty straightforward, right? Unfortunately, categorizing is a bit more complicated than you might think. We’ll give you all the details you need to properly categorize and work with the amazing variety of people your company has on staff.
First things first: why is the difference so important?
You haven’t spent hours thinking about the independent contractor vs. employee distinction? You’re not alone. But here are several reasons why it’s crucial to properly categorize your team:
1. The law (not you) dictates who’s an independent contractor and who’s an employee.
Did your employee sign a contractor agreement, an employment agreement, or do they just show up a few days a week to help out? No matter what your arrangement is, your team’s employment classification is ultimately based on the nature of the work they do and how they do it.
2. Employees and independent contractors are treated differently for tax purposes.
Companies are expected to pay certain taxes on behalf of their employees. This includes employment tax for the state and federal government, Social Security tax, and premiums for workers’ comp and disability. On the flip side, companies don’t need to pay these taxes for independent contractors. Instead, contractors are responsible for their own “self-employment tax.”
Missed the memo? Time to get things in order. Improperly classifying your workers could make you liable for back taxes.
Similarly, if you incorrectly categorize an independent contractor they may be able to file an unemployment claim against you when their contract ends. Department of Labor requirements can also mean thousands of dollars in fines for accidental misclassification. Intentional or fraudulent misclassification of employees has led to hundreds of thousands of dollars in fines. No thank you.
3. Sometimes, independent contractors come with more liability.
You hear someone yell, “ouch!” around the corner. One of your employees just got hurt on the job, and you feel terrible. But if you correctly categorize them things probably won’t be so dire. How they’ll be able to recover often depends on their status, and in many cases, employees are the only ones who can receive workers’ compensation. Independent contractors, though, may be able to sue you under certain conditions, so make sure your workers’ comp policy is sealproof.
4. Employees are subject to different work expectations.
Some industries, like health care and education, are a jungle gym of rules and regulations that can have a real impact on your employees’ lives. This isn’t true across the employment spectrum, but if you’re in a highly specialized or professional industry, you may need to document additional rules surrounding the work your employees do.
So, how can you tell which is which?
Ah yes, the golden question. Luckily, the IRS, the Fair Labor Standards Act, and the common law have all helped define the differences between an employee and an independent contractor.
Unfortunately, it’s not totally cut and dry. The IRS generally assumes an employee relationship, but the line between the two can sometimes be ambiguous.
This handy chart can help you figure out the difference between the two:
Why does it matter? Because employees…
An independent contractor:
Why does it matter? Because contractors…
However, these are not hard and fast rules. Other considerations also come into play when categorizing an employment relationship such as how permanent the relationship has been in the past and even how often the individual works for your company. Still scratching your head? Don’t worry. Just fill out Form SS-8 and the IRS will do all the deciding for you. Phew.
It’s never a good idea to try to get around employment laws by falsely categorizing an employee as an independent contractor. Usually, you’ll be subject to consequences under the tax code, at the very least, and you may even be subject to a lawsuit in federal court, under certain circumstances. So just don’t do it.
When it comes to worker classification, the best thing you can do is be proactive, not reactive. Rather than waiting for a potentially precarious situation to occur, you should make it clear to your workers exactly how they will be classified from the start — and make sure their roles stay within the definitions provided by the IRS. It takes a bit of introspection and research to figure out how the two types compare, but once you get it down, your employee vs. independent contractor classification skills will put you at the top of your class.