How Do I Determine If a Person is an Employee vs Contractor?
It is extremely important to understand the difference between an employee vs contractor. The IRS takes this distinction very seriously, and there can be legal ramifications if you don’t follow the rules and guidelines they lay out. Therefore, if you are a small business with an LLC (or any business structure for that matter), you need to be familiar with the critical differences between these designations.
This article will take the IRS guidelines and break them down to help you better understand the information they provide on the difference between employees vs. contractors.
Employee vs Contractor: An Overview
Under the classifications mentioned above, you can bring on help in the form of an actual employee of your business, or you can outsource work to a contractor. Depending on the structure you set up, an employee will provide more support, while a contractor can be easier to manage with less overhead.
If you decide to bring employees on staff, you’ll be responsible for withholding taxes for those individuals (including unemployment, social security, Medicare and obviously income).
When you are working with a contractor, you do not need to withhold any of the taxes mentioned above. Instead, it’s the contractor’s responsibility to pay their own taxes as a self-employed individual. Depending on the total amount the contractor makes, they may receive a 1099 tax form from your business. This generally takes place if the contractor is paid more than $600 for the year from any given business he or she works with.
Three Categories to Classify Employee vs Contractor
The IRS breaks down the differences between an employee vs contractor by looking at three different categories: behavioral control, financial control, and relationship. Below we’ll discuss how the IRS classifies each to give you a better understanding and allow you to decide which you prefer for your own business.
1. Behavioral Control
This category is where the business has the ability to dictate the type of work that needs to be completed. If the business is dictating everything, generally the person on the other end will be classified as an employee. If the business has the person work within their building, this also would classify them as an employee vs contractor whereas the contractor can work from anywhere he or she wishes off-site. A business that expects someone to work certain hours would also classify them as an employee.
Contractors have the ability to work whenever they want and are not confined to the normal 9-5 that many businesses follow. When a business trains someone on how to do a certain job, or who has ongoing training would constitute that an individual is an employee. A contractor does their own training and it is not dictated by any client they work with.
2. Financial Control
How someone is paid and how they get paid can help differentiate an employee vs contractor. If a company is paying an individual weekly or bi-weekly and control the amount paid (say a fixed amount), the individual is considered an employee. Employees generally get paid for working a designated time-frame such as 8 hours a day or 40 hours a week. This is different than a contractor as they get paid generally by the job and when the job is completed – most commonly by a fixed fee designated by the contractor.
If there are expenses paid by the company, this also denotes an employee, as a contractor incurs unreimbursed expenses out of their own pocket that is not paid for by the company (client). If the company you work with dictates that you can only make money working with them (such as a non-compete agreement or contract), you are definitely considered an employee since contractors are free to work with whoever they want and make money from any business they wish to provide their services to.
3. Relationship
For this category, it all comes down to how the individual and the business interact. There can be contracts in place for both an employee and contractor. But the wording is what determines an employee vs contractor. If the contract spells out how a project will be handled, time of completion, and how and when someone will be paid will generally be a contractor. A contract signed by an employee states employment with the company, the position being held, the hours needing to be worked, the responsibilities of the employee, and any and all benefits/programs available such as insurance, pension, vacation, sick pay, etc. for the employee.
A contractor does not get any sort of benefits, retirement plan, 401k, etc. from a business they work with. If there is an expectation for the person to indefinitely work with the business, that individual is most certainly an employee. A contractor is free to come and go in terms of working with the company.
Hopefully, the above has helped you understand employee vs contractor. Knowing the difference is extremely important as misclassifying an employee can cause you penalties and legal ramifications by the IRS.
Don’t be afraid to start your own business because of all the rules and regulations. Owning your own business helps bring freedom to your life and the ability to do what you love. But at the end of the day, you still need to understand the differences between employee vs contractor. If you have any questions or uncertainty, check the link to the IRS guidelines for yourself for more information.
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