The first thing you should know about the difference between being an employee and being an independent contractor is that the choice may not be up to you. Stay on the right side of the law ... and the IRS.
The first thing you should know about the difference between being an employee and being an independent contractor is that the choice may not be up to you. You should also know that you have distinct and important obligations with either classification. Use our guide here to determine your legal obligations and your tax liability, but consult an expert if you are at all unclear on how to classify your situation.
What determines whether someone is an employee or independent contractor is the level of control an employer has over the worker. Generally, what constitutes an employee is that the employer has the right to discharge the employee and also provides a place to work and tools to work with.
If you are an employer and have incorrectly categorized your employees as independent contractors, you could be liable for back taxes and penalties. An employer categorizing her workers as employees must comply with certain regulations. An employer must withhold federal, state, and social security taxes from an employee’s check, as well as pay a portion of unemployment taxes. An employer also must pay for worker’s compensation insurance, a fund that covers employees injured in the line of work.
Independent contractors are required to pay their own income taxes on a quarterly basis (the employer does not withhold taxes from a paycheck). You need to estimate your total year’s taxes and pay the amount in equal quarterly installments. If you fail to pay the taxes or pay an amount far below what you owe, you could be subject to a fine. At the end of the year, the employer provides independent contractors with a 1099 form, indicating the year’s earned wages. An employee receives a W-2 form at year’s end, which shows total wages earned and all monies withheld.
When filing year-end tax returns, an independent contractor will obviously have more deductions. She can deduct from her gross income monies that she spent out of her pocket on expenses. This “adjusted gross income” may lessen the independent contractor’s tax liability.
Employees must report tips they receive each month in excess of $20. This includes both tips received in cash and those that charge customers add to the bill. Taxes are still due on tip earnings. There are strict rules regarding reporting tips, although the thrust of the law is aimed at food and beverage establishments, where tipping is customary If you need more information on this subject, consult an IRS publication entitled “Employer’s Annual Information Return of Tip Income and Allocated Tips” (Form 8027).
The IRS provides 20 categories by which it judges the employee-employer relationship. The criteria are outlined as follows: Instructions. You are considered an employee if you must abide by instructions about where, when, and how to work. If there are no implicit rules but the employer has the right to set those rules, you are an employee.
Training. An employee is trained to perform services in a particular manner. Independent contractors receive no training and perform their services by their own methods.
Integration. An employee’s services are integrated into the business operation because the services are important to the success or continuation of the business. This shows that the employee is subject to direction and control. An employee who is integrated in the salon would follow the salon’s rules and regulations, keep a permanent work area, attend salon meetings, etc. An independent contractor would not necessarily be required to follow certain in-house rules or attend meetings.
Service rendered personally. An employee renders the services personally. This shows that the employer is interested in the methods as well as the results. An independent contractor may or may not perform services herself. If she is ill or unable to work, she may hire a substitute; whereas if an employee is sick or unable to work, it is the responsibility of the employer to get a substitute.
Hiring assistants. An employee works for an employer, who then hires, supervises, and pays assistants. An independent contractor hires, supervises, and pays her own assistants. This means that if you’re an employee and you require an assistant, the hiring is done by your supervisor. If you’re an independent contractor requiring assistance, you hire that person yourself (and are responsible under a separate contract to that person).
Continuing relationship. An employee has a continuing relationship – where work is performed at frequently recurring intervals — with an employer.
Set hours of work. An employee normally works full time for an employer (however, there are part-time employees) during times determined by the employer and wholly at the employer’s discretion. An independent contractor can work when and for whom she chooses.
Work done on the premises. An employee works on the premises of an employer or works on a route or at a location designated by the employer. While most independent contractor nail technicians do work on the premises of the employer, the freedom not to do so indicates an independent contractor relationship.
Order or sequence set. An employee must perform services in the order or sequence set by an employer. (Note the recurring theme of employer control.)
Reports. An employee submits reports to an employer. This shows that the employee must account to the employer for his or her actions.
Payments. An employee is paid by the hour, week, or month. An independent contractor is paid by the job or on a straight commission. Be careful: Just because someone is paid commission doesn’t mean she’s an independent contractor.
Expenses. An employee’s business and travel expenses are paid by an employer.
Tools and materials. An employer furnishes an employee with tools, materials, and other equipment.
Investment. An independent contractor has a significant investment in the facilities he or she uses in performing services for someone else.
Profit and loss. An independent contractor can make a profit or suffer a loss.
Works for more than one person or firm. An independent contractor gives his or her services to two or more unrelated persons or firms at the same time. While an employee may work two jobs, a characteristic of independent contractors is that they have several employers.
Offers services to the general public. An independent contractor makes his or her services available to the general public.
Right to fire. An employee can be fired by an employer. An independent contractor cannot be fired so long as he or she produces a result that meets the specifications of the contract.
Right to quit. An employee can quit his or her job at any time without incurring liability An independent contractor usually agrees to complete a specific job and is responsible for its satisfactory completion, or is legally obligated to make good for failure to complete it.