Independent Contractor vs Employee Pros And Cons

Completing personal projects during this time is typically frowned upon, prohibited, or even regarded as a breach of a non-compete agreement built into the employee’s contract. To avoid such consequences and maintain your status as a well-behaved, honest citizen—whether you are a business owner or a freelance worker—continue reading to understand the difference between an independent contractor and an employee. When a worker is an independent contractor, the hiring party is not required to make any of these payments. If the worker receives benefits like insurance, vacation pay, sick pay, or any long-term financial planning, the IRS is much more likely to view that as an employment relationship. The final major factor that IRS looks at to determine whether a worker is an employee or independent contractor is the overall structure of the relationship between the parties. The IRS has identified ongoing discrepancies on balance sheets involving partnerships with over $10 million in assets, which is an indicator of potential non-compliance.

Whats the Difference Between an Independent Contractor and an Employee

Employers must also withhold Social Security and Medicare taxes (together known as the Federal Insurance Contributions Act [FICA] taxes). Only the employer pays FUTA tax; it is not deducted from the employee’s wages. For one, employees are protected under the Fair Labor Standards Act (FLSA), which requires time and a half overtime pay. Businesses also pay employer-paid payroll taxes, such as federal unemployment taxes (FUTA), state unemployment taxes (SUTA), and the employer portion of FICA taxes. Employees, also called common-law employees, earn regularly scheduled paychecks. Their employer must withhold a portion of employees’ paychecks for Federal Insurance Contribution Act (FICA) taxes, state income tax, and federal income tax.

The law is clear

The amount independent workers should set aside for tax varies depending on their earnings and work-related expenses, but they should estimate their tax and pay toward it each quarter. It is also important for employers to learn their state’s laws on independent contractors, as they may vary slightly from federal rules. This will matter for state and local taxes, as well as worker safety rules. Classifying workers as either employees or independent contractors is important. The correct worker categorization has a profound impact on businesses because it affects not only how workers are paid, but how the government gets paid.

  • The problem is, of course, that employers can come to over rely on independent contractors and, over time, begin to treat them as employees.
  • (Employees also use IRAs when their employers offer no retirement or pension plans.) In Canada, RRSPs are an option.
  • Contrary to independent contractors, employees working under an employer that withholds taxes have it much more straightforward.

A misclassified employee can also result in financial claims including reimbursement for overtime, retirement contributions, or social security contributions, amongst other benefits. Make sure you are aware of all your obligations relating to both your employees and your independent contractors. Employees have more predictable work lives and protections, and sometimes work fewer hours, than independent contractors do. In a 2009 survey, Pew Research found 95% of self-employed workers were completely or mostly satisfied with their jobs compared to 89% of traditional employees. Far more employees reported working for money (50%) than independent workers (38%), who often reported working because they wanted to (32%), or at least equally for both reasons.

Independent Contractor vs Employee Pros And Cons: Everything You Need to Know

SHRM had commented previously that “the business community and workers are left applying numerous factors in a variety of ways that is mired in uncertainty and, therefore, unnecessary risk,” the rule noted. The new rule will reduce worker misclassification, stated Wage and Hour Division Administrator Cheryl Stanton. She added that the rule’s examples also will provide greater clarity for the workforce. Whats the Difference Between an Independent Contractor and an Employee Finally, within this category, the IRS looks at whether the worker was trained by the company. “Protecting hard-working taxpayers is a critical component to ensuring the success of the nation’s tax system, and the IRS will be working throughout the fall and into the 2024 filing season to take steps to help people.” The IRS has launched numerous compliance efforts to address serious issues being seen.

When a worker is an employee, employers must pay state and federal unemployment tax, social security tax and workers compensation/disability premiums to a State Insurance Fund. If an employer-employee relationship exists (regardless of what the relationship is called), then you are not an independent contractor and your earnings are generally not subject to self-employment tax. However, your earnings as an employee may be subject to FICA (social security tax and Medicare) and income tax withholding. If an employer files a form 1099 for an employee, which unintentionally misclassifies the employee as an independent contractor, the liability for federal income tax withholding is limited to 1.5 percent of employee wages. Last, employees who lose their job due to no fault of their own can receive unemployment benefits, which compensates them while they seek new work. Independent contractors usually aren’t eligible for unemployment compensation, yet they also don’t pay federal or state unemployment taxes.

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