Difference Between an Independent Contractor and an Employee
The key difference between an independent contractor vs. an employee comes down to taxes. An employer is responsible for withholding taxes, including income tax, social security tax, and Medicare tax from an employee’s paycheck. An employer is not responsible for withholding taxes from an independent contractor. Instead, an independent contractor is responsible for paying both employer and employee taxes to tax authorities.
Do you know the difference between an independent contractor and an employee? As you grow your business, understanding the distinction between these two types of workers will be critical.
After all, hiring an independent contractor vs. an employee comes with a unique set of pros and cons, especially when it’s time to file your business taxes.
So, what is the difference between an independent contractor vs. an employee—and why should you hire one type of worker over the other?
We’ll answer these questions—and more—in our guide.
Independent Contractor vs. Employee Taxes
Many people think they have a choice when deciding whether to pay a worker as an independent contractor or an employee, but that isn’t the case.
Legally, there are big differences between an independent contractor vs. an employee—the most important difference is in the withholding and payment of employment taxes (i.e. payroll taxes).
If a worker is classified as an employee, then the company must withhold income tax, social security tax, and Medicare tax, as well as any state and local income taxes from the salary or wages paid to the worker. The company must also pay social security, Medicare, and federal and state (if required) unemployment tax for the benefit of the employee.
If a worker is classified as an independent contractor, then the company typically does not withhold any taxes from the amounts paid to them. The company is not required to pay any taxes for the benefit of the worker. Instead, the independent contractor is responsible for paying both the employee and the employer portion of the federal and state taxes directly to the taxing authorities.
Since payments to independent contractors aren’t subject to employee withholdings or employer-paid taxes, some business owners prefer hiring independent contractors over employees. But they must exercise caution because paying a worker as an independent contractor requires that you meet several standards.
Keep in mind that paying someone as an independent contractor when they qualify as an employee is illegal and can be costly.
Independent Contractor vs. Employee Checklist
Common law rules can help you learn how to determine an independent contractor vs. employee.
Generally, a worker is an employee if:
- Your business controls what work will be done and how it will be done even if you give the employee freedom of action. This means that you retain the right to control the details of how the services are performed.
- Your business provides the equipment and materials the worker uses to complete the work.
- Your business provides benefits to the worker, such as paid time off, insurance, retirement, or other fringe benefits.
- Your business pays the business expenses of the worker, such as office rent, insurance, supplies, or other expenses and reimbursements.
Generally, a worker is an independent contractor if:
- The worker is a medical or financial professional, building or trade contractor (like a plumber or electrician), engineer, designer, or another professional who provides services to the general public.
- They service several to many different customers or clients who pay them directly for their services.
- They control when and how the work will be performed and control all details of the work performed.
Why Hire an Independent Contractor vs. Employee?
Whether you choose to hire an independent contractor vs. employee will be based on a variety of reasons. When you hire an employee, you have greater control over how they work. Employees are required to show up at a specific time and fulfill their responsibilities in a manner you designate. Independent contractors, however, are different. Since they are a separate entity, they have greater autonomy over their work processes.
Hiring an independent contractor vs. an employee is often an attractive option because independent contractors can be more cost-effective—plus, you don’t have to go through the process of withholding taxes. You also don’t need to pay more money in company benefits, like paid leave and employee insurance.
On the other hand, however, consistently hiring independent contractors over employees can make workflow processes difficult, especially when you have to spend significant time onboarding new contractors and training them on the ins and outs of your business before they can actually get started.
Independent Contractor vs. Employee Chart
Income tax, social security tax, and Medicare tax withheld from paycheck
Responsible for paying their employee and self-employment taxes
Can receive company benefits (e.g. paid leave, insurance, or retirement)
Does not receive company benefits
Generally receives instruction on what, when, where, and how they will work
Has greater control over their work processes
Works for one employer and typically reports to a supervisor or manager
Typically has multiple customers or clients
Receives tools and materials necessary for completing their work, plus reimbursement for business expenses
Responsible for covering their own business expenses (e.g. rent, applications, tools)
As you can see from the above chart, independent contractors and employees differ in several ways. If you’re ever trying to determine whether someone should be considered an independent contractor vs. an employee, run through these criteria to help inform your decision.
Independent Contractor vs. Employee Test
Do you think you know how to determine an independent contractor vs. an employee? Let’s test your knowledge. Let’s see if you can identify whether somebody is an independent contractor vs. employee in the following scenarios.
Test 1: Joyce (Marketing Professional)
Joyce is a marketing professional who works around 15 hours per week for Company A providing social media and other marketing services. She works out of her home and pays all of her own business expenses including the cost of the applications and tools she uses to promote Company A.
Joyce charges Company A an hourly rate for her services and provides similar services to Companies B and C.
Joyce meets all of the tests to be classified as an independent contractor because she controls how, when, and all the other details of how the work is performed for Company A. She also pays for her own business expenses and provides the same services to other companies.
Test 2: Laura (Content Writer)
Laura is a content writer who works for Company A for about 15 hours per week. She writes articles and other marketing materials for advertisements and social media campaigns.
Laura performs her work onsite at the Company A office using the company’s computers and other office resources. She also reports to the VP of marketing. Laura is paid an hourly rate for her services and doesn’t provide marketing services to anyone else.
Laura does not meet the tests to be classified as an independent contractor because even if she has freedom of action with her job, she is using Company A’s resources and has someone overseeing when and how she performs her work.
Another determining factor is the fact that she doesn’t provide her services to the public, only to Company A. Based on the circumstances, Laura should be classified as an employee of Company A.
These two scenarios were pretty straight forward and clearly illustrate the difference between an independent contractor vs. employee, but sometimes the facts aren’t so cut and dry.
Let’s take a look at a third scenario:
Test 3: Tim (Landscaper)
Tim works as a landscaper for Company D about 15 hours per week, performing work for clients of Company D as directed by the owner. He uses mowers and other equipment provided by Company D to complete his work and is paid hourly for his services.
Company D reimburses Tim for mileage and other expenses for using his personal truck to complete the work. Tim also works for Company E providing landscaping services directly to them but uses his own mower and equipment to complete that work.
Tim is an employee of Company D because he does not meet all of the common law rules to be an independent contractor. Even though he provides the same type of services to Company E, Company D provides Tim with the equipment used to do the work for their clients and dictates when and how the work should be performed.
Company D also reimburses Tim for his mileage and vehicle costs, which is typical of an employer-employee relationship.
Based on the above scenario, Tim might be classified as an independent contractor by Company E if he meets all the required common law rules.
Repercussions of Misclassifying a Worker
Although these three independent contractor vs. employee tests may seem simple enough, understanding the key distinctions is critical, so you can comply with legal guidelines.
According to the IRS, “There is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors that are relevant in one situation may not be relevant in another.”
Many businesses mistakenly believe that they have some freedom in determining how to classify their workers, but this just isn’t the case. In fact, misclassifying workers can be costly. If you pay a worker who should be an employee as an independent contractor—and have no basis for it—you might be held liable for employment taxes for that worker along with interest and penalties.
In fact, the correct classification of workers is a huge part of payroll compliance, so you’ll want to take the time necessary to properly classify any worker you plan on hiring before you actually bring them on to your team.
Luckily, the IRS has a webpage dedicated to this topic to help you determine the difference between an employee and an independent contractor.
If you’re still in doubt, however, you can file a Form SS-8, which describes the nature of the relationship between the payer and worker, and the IRS will review the facts and circumstances and give you an official determination of the worker’s status.
This process can take up to six months to complete but may be well worth the effort if you hire several workers who perform the same types of services under the same circumstances.
As you grow your business, it’s critically important that you understand the difference between an independent contractor vs. an employee.
Take the time to absorb the various distinctions and revisit our independent contractor vs. employee chart if you need to refresh your memory. Correctly categorizing the people who work for you will help you avoid any legal (and sometimes costly) repercussions. And—if you need any assistance, you can reach out to an HR or business tax advisor for guidance.