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Employee vs. Independent Contractor – What’s the Difference and Why Does it Matter?

Employee vs. Independent Contractor

What's the difference?

Misclassifying an employee as an independent contractor can result in costly consequences that can be detrimental to your business. As the employer, you may become liable for the payment of taxes, including federal income tax, social security tax, Medicare tax, federal unemployment tax and state unemployment tax.

Certain factors will classify a worker as either an employee or as an independent contractor.

The IRS determines employee and independent contractor status based on the following three, broad criteria:

  • the relationship between the employer and the worker;
  • the compensation structure;
  • and, the level of control the employer has over the worker.
Employees  (sometimes called common law employees) are individuals who work for an employer that controls the work— when the work is performed and how it’s performed . The individual is hired into your organization on a permanent basis and is subsequently paid periodically through the main payroll system. That means you’re also expected to deduct various obligatory amounts from their gross pay every single time you remit their compensation—for example, payroll and social security taxes.

An independent contractor is an individual who performs services for you, but you control only the result of the work. Independent contractors, are basically third-party entities that you engage on temporary terms, without absorbing them into the company’s workforce, and they’re ultimately paid without deductions.

Independent contractors typically sign contractor agreements, while employees sign standard employment contracts.

If you hire an independent contractor and pay him/her more than $600 during the year, per the IRS, you must issue a Form 1099-MISC. A Form 1099-MISC is proof of how much you paid the independent contractor for work performed for your company. A Form 1099-MISC is to independent contractors what the Form W-2 is to employees. Failure to issue a 1099-MISC by the IRS deadline, which is usually in mid to late February, may result in penalties.

And, don’t forget to obtain a signed Form W-9 from those vendors to whom you pay for services rendered. Businesses use IRS Form W-9 to request Taxpayer identification Numbers and Certifications. Services rendered can include, but are not limited to, subcontracting work, building maintenance/repair, lawn maintenance/landscaping, and computer and legal services. And, if you’re making rent payments, you should issue a 1099 to your landlord, so be sure to obtain that signed Form W-9 from your landlord, too!

If you’re unsure how to classify a worker, please reach out to us—we want to help you make the right decisions.

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