When you are running your business, you may determine that you need extra help or services. You may decide to look to find employees or outside contractors for help. Maybe your business depends on well-written content, and you depend on professionals to write it, while staying covered by a contract template.
However, when it comes time for taxes, you’ll need to know whether your professionals are independent contractors or actually employees. Understanding the difference can be tricky, but once you do, you can be confident you’ll have fewer worries in the future.
In this article, we’ll go over the differences between employees and 1099 independent contractors. We will discuss how to decide which one is right for you, as well as other important considerations that need to be made when hiring either type of worker.
Are Employees or Independent Contractors Right for You?
The IRS has a few key guidelines that help businesses decide whether they have 1099 contractors or employees. Consider these five variables when deciding which type of workers you have:
Control over how work is done. If you require a worker to be in the office at certain times, they’re probably an employee. Freelancers or independent contractors choose when and where they do their work.
Compensation structure. While most employees are paid a regular annual amount or wage, contractors are paid by the job – and need to receive 1099 at the end of the year to complete their taxes.
Training is not provided for independent contractors. If training is mandated, the worker is an employee.
Contractors use their own equipment whereas most employees have their computers and other office supplies provided by their employer.
Finally, freelancers work for multiple companies generally. If you are asking someone to work only for you, they are likely an employee.
Misclassification of a person as a contractor when they behave as an employee can lead to problems at tax time, and even issues with employment law, so it’s a good idea to make sure you classify all hires correctly.
The Pros and Cons of Hiring Employees and Independent Contractors
The above guidelines illustrate many of the advantages and disadvantages of hiring contractors vs. employees. We'll talk about more of the pros and cons of hiring an employee or an independent contractor here.
Working With A Self-Employed Independent Contractor
Independent contractors are typically hired by a business in order to provide goods or services outside of their primary occupation. They are hired to complete a specific job, and they're not required to work regular hours.
If you are paying someone as a independent contractor, you’ll save money on retirement, health, and other 1099 benefits. However, you should expect that they’ll request a higher hourly rate than an employee would, negating some of those savings.
This is because they usually have a high degree of specialization or expertise in their industry. If you need a professional team member for a short-term project, occasional work, or work that can be performed remotely, freelancers can save you time and money.
Freelancers, however, are typically more concerned with growing their own business than growing yours long-term. Typically, an independent contractor operates as a freelance business and may perform work for multiple clients or companies at a time. This means their time is split among different projects, which could lead to a lack of focus on your project. For example, freelance writers or advertisers could have different clients at the same time as well as Uber and Lyft contractors could drive for both companies, etc
If you choose an independent contractor for a longer project, they may not be as committed to the success of that project as an employee would be (employees are typically more loyal to their employer and will put in additional work hours when necessary).
Contractors are good for jobs that only need to be completed once or sporadically, like a one-time website development project.
Hiring An Employee
An employee is a person who works in the service of another person under an express or implicit work contract template of hire that gives the employer control over the details of work performance.
In other words, when you hire an employee, you have the right to control their work. You can also require them to be at work at certain times and prevent them from working for other firms. Employees are hired on an indefinite basis with the expectation that duties will be completed as instructed. Employees enjoy greater stability in income due to their employment status. Employees have more long-term job security so they're better suited for tasks that will take months or years to complete.
However, you may end up paying for non-productive time since they are not paid by the project. Additionally, keep in mind that your employee has more general knowledge about your business than contractors would, and can help you build longer relationships with potential clients.
You must also follow regulations for payroll taxes, which include paying half of each employee's FICA taxes (Social Security and Medicare) and collecting the other half from them.
Classification Of An Employee Or Independent Contractor
The practice of misclassifying an employee as an independent contractor is known as employee misclassification. Employers can avoid paying unemployment, health insurance, social security, and other taxes on their employees, as well as workers' compensation and unemployment insurance, by using this method.
There was a huge lawsuit in 2015 surrounding Uber and the status or misclassification of drivers as an independent contractor instead of an employee. The financial cost of these lawsuits for the ridesharing business over the misclassification of independent contractors went well over $100 million dollars.
To avoid any legal issues by the misinterpretation of the rules or classification, here are some questions you can ask yourself to determine if the worker is classified as an employee or an independent contractor.
What degree of control do I have over the worker?
Evaluate the business relationship to identify the degree of control between the individual and your company. A worker is an employee if you have the authority to direct how he or she performs his or her duties. This is true regardless of whether you actually exercise that right—that is, whether you reject to manage the specifics of how the person does the job. If you can control what hours they work or control the details of how the work is done, they are an employee.
What are the financial arrangements for how the worker is paid?
Independent contractors submit invoices for their services rather than working for a set salary. During the initial contract negotiations, pay and payment terms are usually discussed. You should also ask yourself if the worker is paid for tools, repaid for expenditures, and who provides the necessary materials.
On the other hand, a steady hourly rate or compensation is often guaranteed to an employee. However, in some professions, such as meeting with a lawyer for 1099 consulting, it is normal to pay independent contractors on an hourly basis.
Is the worker responsible for bringing their own tools and materials or is the employer responsible for providing them?
Independent contractors typically have their own tools they use. If you require workers to provide their own materials, they are likely classified as an independent contractor. Employees usually work on a salary or hourly wage and you provide the tools necessary to do the job.
Does the person receive training from your company?
If you require the person to attend mandatory meetings or training, auditors and courts regard this as evidence of control over independent contractors. Working with independent contractors should not make meetings necessary (unless mandated by law), and they should not be referred to as "training" sessions. They are their own small business.
If a worker performs services that are directly related or tied to your company's main operations, the IRS is more likely to classify them as an employee.
Do you require the individual to personally perform the contracted services?
An independent contractor is classified as a small business owner. This means independent contractors could hire other people to help them with the contracted services. Employees who are not self-employed independent contractors typically have no choice in this matter
Is the person working on a one-time project, or is he/she expected to continue work after the initial contract expires?
This question should be easy to answer if you're just looking for specific tasks that need completing. Remember, independent contractors, are not full-time workers.
Is the worker allowed to work for other companies while they are performing their services?
A freelancer will be allowed to work with a variety of customers and companies at the same time they are working with an employer. You can direct an employee to not work with other companies at the same time as working for your business.
Are you providing any benefits to the individual?
Contractors must obtain his/her own benefits including workers' compensation, disability, etc, and not receive any vacation pay since they are a small business. If the worker is a contractor, they are self-employed and should not be entitled to any typical employee benefits or from any government agency.
It is a good idea to get an employment lawyer or tax professional if you have any questions about your employment relationship status and how you classify a worker.
Is there an opportunity for profit or risk of loss?
A profit or loss can be made by an independent contractor, but not by an employee. The IRS as well as the courts are likely to consider you an employee if you are paid a set amount and do not incur any expenses directly relevant to the service you are performing.
Can you terminate the worker at any time?
If any party can terminate the connection at any time for any (legal) reason, the worker is more likely to be an employee. If the parties' termination rights are governed by a contract, the worker is more likely to be a contractor.
Are you withholding taxes for the worker?
The independent contractor is responsible for paying his or her own taxes and completing all the needed federal papers. They are responsible for handling all of their federal income and self-employed taxes. If you are setting aside money to pay the IRS for an individual, chances are they are an employee. For an employee, the company withholds income tax, Medicare, and Social Security.
Tax Implications
The tax structure is very different for employees and independent contractors. If a company hires a team member categorized as an employee, the company withholds income taxes, unemployment insurance, Social Security, and Medicare taxes from wages paid. They must deposit, report, and pay employment taxes. A company is required to file a W-2 for each employee.
When working with contractors, you do not withhold income taxes. Instead, the freelancers are considered small business owners, and your company is their client. They are also expected to pay their own self-employment taxes, often quarterly. In these kinds of working relationships, businesses provide freelancers and independent contractors with a 1099 document that states how much they were paid over the previous year for their service. For more information on 1099 and other self-employment tax requirements, visit the IRS website.
Keeping it legal
Should you choose to bring on freelancers, and are classified as independent contractors under the IRS' rules, make sure that you follow all of the relevant labor laws. The IRS created a 20-point checklist for determining whether someone is an independent contractor (1099) or employee (W-2). These questions include those outlined earlier in this article, plus others that go into more detail. Download the checklist here.
You’ll also want to put your independent contractor agreement template in writing. Our app for contractors could help with that. Use Bonsai’s contract tool to create written guidelines on work expectations. When both parties sign a contract, you can be confident that you’re on the same page about expectations, and you will be more likely to have legal recourse if the work doesn’t go well.
The difference between employees or full-time workers and independent contractors is a key decision for any company. Both have advantages and disadvantages, but figuring out which one would be best to onboard can be difficult. Now, let's dive into when you should bring on an employee or an independent contractor for your business.
When You Should Hire An Independent Contractor
In short, you should look to onboard an independent contractor for your business if you need:
- Specialized, professional work done without your control or supervision
- You just need the assistance of an independent contractor for short-term work or services to complete a project or task
- You need services performed that is beyond the scope of your main company
- Determine if you want to avoid a large amount of federal government and State regulations for wages, salaries, employment benefits, withholding Social Security and Medicare taxes, etc that comes along with hiring an employee instead of an independent contractor
Now, here are some reasons why you should hire an employee for your business and not an independent contractor.
When You Should Hire An Employee For Your Business
Here are some reasons why you should hire an employee for your business and not an independent contractor.
- You'll need a more long-term relationship with a worker and ongoing work
- You want a high degree of control for the work or services performed
- If you want to be able to control the worker's working hours as well as the tools and equipment he or she uses.
Now that talked about the different situations related to contracting a person or bringing on a full-time worker, let's get into how to build your own freelance team.
Building Your Freelance Team
Working with independent contractors can be a great way to get high-caliber work without paying high-level salaries, especially if you don’t need a full-time team member. Whichever you choose to help grow your business, make sure you understand the rules and differences.
Once you know how you are going to classify your freelance team, you can focus on finding the perfect one for your company. Some ways of finding great candidates include:
- Asking for recommendations from other business owners
- Posting an online job advertisement
- Searching online for top-rated providers
You’ll have to put a little legwork in to find the perfect independent contractor, but for most businesses, it’s a worthwhile investment. There may be a bit of a learning curve - remember, working with a freelancer is different than working with an employee, and you may need help. Consider seeking the advice of a freelance specialist to teach you how to manage 1099 contractors, so your business runs smoothly, or start using a Freelance Management System like Bonsai today - sign up for a free trial today.
