How to Determine The Difference Between an Employee & Independent Contractor

One way is an independent contractor and the other is an employee

Whether a worker is an employee or an independent contractor will play a major role in payroll processing. Yet, many business owners still don’t understand the differences between the two and it ends up costing them BIG time. The following article will help you determine the key differences between employees and independent contractors, saving you and your business from being open to liabilities.

Withholding Taxes

With an employee, rather than an independent contractor, an employer withholds income tax, Social Security tax, and Medicare tax from their wages. This allows the employer or company to offer healthcare, insurance, PTO, and other benefits which are often required to be provided for full-time employees who exceed 32 work hours per week.

An employee will file a W-4 reporting all tax exemptions to the employer, and the employer will file a W-2, reporting all money paid to the employee during the tax year.

An independent contractor on the other hand, does not have any taxes withheld from their employer and is responsible for claiming their own income. An independent contractor will file a W-9 reporting taxpayer identification to the employer, and the employer must file a 1099 if annual payment to the individual exceeds $600.

Salary vs. Project Payment

Payment between an employee and independent contractor is another one of the key differences that will affect both payroll and taxes. A regular employee typically works for a single employer and will have a continuing relationship with the company. An employee will be paid on an hourly basis or annual salary, depending on their contract agreed to during the hiring process.

An independent contractor, however, can work for multiple clients and will be paid on an individual basis for separate projects. Because each project will be different, compensation will be determined based on the contractor’s existing skill set and amount of work required. Payment is generally received upon project completion and is paid directly without tax withholding or documentation in payroll.

Labor Laws

Employment and labor laws only apply to employees. The list of compliance issues that small business owners can face, goes on and on, from not adhering to federal or state laws on overtime wages to breaking pay period regulations. Employees are entitled to certain benefits such as paid breaks, lunch hours (depending on shift), supply reimbursement, PTO, direct deposit, etc.

An employer who is unaware of such laws and regulations, may be open to major liabilities such as fines, lawsuits, and audits. Naturally, these can result in major financial and other burdens.

Independent contractors are not protected by employment or labor laws. As such, they cannot file complaints for unfair treatment, labor disputes, related injury, etc. Contractors must also provide their own supplies, such as computers, printers, paper, office supplies, or any other equipment needed to complete the project and meet its expected quality standards.

Because independent contractors are only hired for temporary work and are categorized under the law as working for themselves, they do not qualify for reimbursement or tax deductions on needed materials.

How Can I Easily Determine The Difference?

The IRS uses a right-to-control test to assess a business’ tax liability. Each state also has accessible tests to determine workers’ compensation and unemployment insurance laws. Digital payroll and onboarding systems like those available through Alliance Resource Services, can help you determine how to categorize workers, ensuring that all current laws are being accounted for and met.

Protect yourself and your business from the possible consequences of miscategorizing employees and independent contractors. Connect with the experts at Alliance Resource Services today to make sure your company is compliant and to make your payroll processing a breeze! For more information on employees vs. independent contractors and other payroll questions, check out our complete payroll guide.

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