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What Is the Difference Between an Employee and a Contractor?

Updated: Oct 2, 2023

When it comes to hiring help for your small business, one of the first decisions you'll need to make is whether to hire an employee or contractor. This can be a difficult decision, especially if you're not sure what the difference is between the two.

In this article, we will discuss the key differences between employees and contractors, as well as when it might be best to use each type of worker.

Understanding the differences between an employee and a contractor is important.

Correctly determining whether the person you are hiring is an employee or contractor is important for a few reasons.

First, the IRS has specific rules about when someone is considered an employee vs a contractor. If you incorrectly classify an employee as a contractor, you could be liable for back taxes, penalties, and interest.

Second, employees are covered by certain laws and regulations, such as the Fair Labor Standards Act (FLSA) and the National Labor Relations Board (NLRB), while contractors are not.

This means that employees have certain rights and protections that contractors do not, such as the right to unionize, minimum wage and overtime pay, and protection from discrimination.

How to Determine If You Are Hiring a Contractor vs an Employee

There are two metrics by which it is determined whether a person is a Traditional employee or an independent contractor: The IRS and the DOL

The IRS has a three-part test:

- Behavioral Control: This looks at who controls how the work is done, such as telling someone when and where to work.

- Financial Control: This looks at who pays for what, including tools, supplies, training, etc.

- Relationship of the Parties: This looks at how much the contractor and business interact, whether they have an employer-employee relationship or not.

The DOL (Department of Labor) looks at six factors:

- Behavioral Control: This looks at who controls how the work is done, such as telling someone when and where to work.

- Financial Control: This looks at who pays for what, including tools, supplies, training, etc.

- Relationship of the Parties: This looks at how much the contractor and business interact, whether they have an employer-employee relationship or not.

- Type of Work Performed: This looks at what type of work is being done and how specialized it is.

- Location of the Workplace: This looks at where the contractor does their work - on company premises or offsite.

- Independent Contractor Status: Finally, this factor looks at other factors to determine if someone is a contractor or employee. These can be things like whether they advertise themselves as contractors if they have a business license, and so on.

State Tests for IC status

Depending on what state you are based in, you may have to comply with specific state-level tests in order to claim contractor status. Generally, these tests look at the level of control the business has over the contractor and whether they are providing services as part of an independent business.

There are a few key things to keep in mind when determining contractor vs employee status. The most important one is that it's not always black and white - often, there can be a lot of overlap between the two classifications. The best way to determine which employment status is right for your workers is to look at the specific factors involved in their situation. Also, it is a good idea to review your employment relationship with those you work with since there are a lot of grey areas you want to develop the distinction between employees. If you do determine that they fit the role of employee then you will need to look at how you are paying for income tax, social security taxes, local state taxes, and workers' compensation insurance. Setting yourself up the right way can help you to avoid potential issues and legal protections.

If you're still unsure after reading this, don't hesitate to reach out to an employment lawyer for more help. And be sure to check out our contractor vs employee calculator below to see which might be the best fit for your business.

What is a 1099 Contractor?

A 1099 contractor is a contractor who is paid via a Form-W-Series, which is used to report independent contractor income and expenses. The form is also known as the "Information Return for Miscellaneous Income." Contractors who are not paid via a Form-W are typically employees.

If you're still unsure of whether someone is an employee or contractor, there are a few key things to look out for:

  • Do they have their own business license?

  • Are they advertising themselves as contractors?

  • Are they providing services as part of an independent business?

If the answer to any of these questions is yes, it's likely that the individual in question is considered a contractor. If not, they're most likely an employee.

How to Get a Determination on IC Status?

At the end of the day, the IRS has the final determination on whether or not a contractor is considered an employee. However, there are a few steps you can take to help make this determination yourself:

Request an Independent Contractor Agreement from the contractor in question - if they are unwilling to provide this, it's a good indication that they view themselves as an employee.

Review past work done by the contractor - do they seem to be operating independently, or are they closely following your company's protocols and procedures?

Look at how the contractor is paid - if you're issuing them a W-­form (a document used for paying employees), it's likely that they're considered an employee. If payments are made via a check or other means outside of a W-­form, this is another sign of contractor status.

Request a Form SS-8 from the IRS - This is a declaration of worker status, and can help to clear up any confusion. The IRS will review the form and make a determination of worker classification.

The Bottom Line

While there are some exceptions, in general, the key difference between an employee and a contractor is that employees are hired to do a specific job, and contractors are hired to provide services.

If you're unsure of someone's status, it's best to err on the side of caution and treat them as an employee. This will help ensure that you're following all relevant tax laws and avoid any costly penalties down the road.

There can be a lot of gray areas when it comes to determining whether or not someone is considered an independent contractor or an employee. In general, though, employees are hired to do a specific job while contractors are hired to provide services. If you're unsure about someone's status, it

If you still can't determine the worker's status, it may be best to seek assistance from a professional.

So When is it Best to Use an Employee vs Contractor?

Generally, you should use an employee if you want the person to be covered by certain laws and regulations, and you should use a contractor if you do not need that level of compliance. For example, contractors are often used for short-term projects or when the work is temporary or seasonal.

Many businesses prefer to use independent contractors because they are not responsible for withholding taxes, paying unemployment insurance, or providing benefits like health insurance. However, using contractors can also be risky because the contractor may not be covered by workers’ compensation if they are injured on the job.

If you’re not sure whether someone is an employee or contractor, you can contact the IRS for guidance.

What If My IC Has Been Designed as an Employee by Mistake?

If you believe that your contractor has been misclassified, you can file a complaint with the IRS. This is commonly known as 530 relief. This allows you to recover the employment taxes that should have been withheld from the contractor’s pay.

Filing for 530 relief can be a complicated process, so it’s best to speak with an accountant or employment lawyer to help you through the process.

When to Ask for Expert Help

As you can see, not only is deciding if your contractor is an employee or contractor complicated but there are also many benefits and risks associated with each classification.

There are also multiple different metrics used to determine contractor or employee status, so it’s important to seek expert help if you have any questions. An accountant or employment lawyer can help you determine which classification is best for your business and how to properly file for 530 relief if needed.

An accountant or employment lawyer can help you navigate the complexities of a contractor vs employee and ensure that you are making the best decisions for your business.

MyAccountingcrew.com can provide contractor vs employee guidance for small businesses as well as expert tax services. Contact us today to find out more!

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