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.
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 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.
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 1099 independent contractor, you’ll save money on retirement, health, and other 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.
An employee is a person who works in the service of another person under an express or implicit contract 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.
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.
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.
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 consulting, it is normal to pay independent contractors on an hourly basis.
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.
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.
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
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.
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.
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.
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.
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.
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.
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.
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 agreement in writing. 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.
In short, you should look to onboard an independent contractor for your business if you need:
Now, here are some reasons why you should hire an employee for your business and not an independent contractor.
Here are some reasons why you should hire an employee for your business and not an independent contractor.
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.
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:
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.
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?