As a small business owner, you may be considering hiring some additional help to grow your business. You have two options as an employer: hiring an employee or hiring an independent contractor. Understanding the difference between the two can be confusing but is crucial to ensure you don’t get fined by the IRS. In this article, we’ll walk through the major differences between employees and independent contractors.
What is an Employee?
Employees are individuals who work for an employer that controls the work of the employee, including what will be done and how it will be done. Employees are paid as salaried or hourly, on commission, or a combination, and may be subject to overtime.
What is an Independent Contractor?
Independent contractors are professionals or workers that offer their services to the general public in exchange for payment. Independent contractors are considered self-employed and their earnings are subject to self-employment tax. If someone is working for your business as an independent contractor, typically you don’t withhold federal or state income taxes and FICA taxes from the amounts you pay them.
How to Distinguish Between Employees and Independent Contractors
The IRS provides three Common Law Rules to help you determine whether you need to classify workers as employees or independent contractors:
- Behavioral: Can your business control the work and how they do their job?
- Financial: Does your business control the financial aspects of the worker’s position such as pay, reimbursement, and tools/supplies provided?
- Type of Relationship: Do you provide the worker with benefits such as time off, insurance, etc.? Is it an ongoing relationship? Does the worker perform a key role in the business?
If you answer yes to all these questions, then the worker should probably be classified as an employee. If you answered no to all these questions, then you will most likely classify the worker as a contractor. However, it’s not always that easy.
The table below provides an overview of some of the differences between an employee and an independent contractor. However, you may find some crossover between the two classifications. Some factors may indicate the worker to be an employee while others indicate an independent contractor. It’s important to look at the relationship as a whole to determine how to classify your worker.
Why Classifying Between Employees and Contractors is Important
As a business owner, you need to understand the difference between 1099 and W2 employees to ensure your business is compliant and avoids misfiling of taxes. We always recommend consulting with a bookkeeper to ensure you avoid misclassification. Both the Department of Labor and the IRS are cracking down on businesses that either purposely or unintentionally misclassify their workers. They’re ready to levy tax penalties and additional fines to make sure you don’t make the mistake again. If you’re still left wondering whether you should hire an employee or a contractor, reach out to us!
With a team of expert bookkeepers on your side, you’ll never have to worry about the health of your business. With Grow Thrive Succeed, we help you organize your business finances so you don’t have to stress over the numbers and can focus on what you love.
