Are You an Employee or an Independent Contractor?

Independent contractors discuss blueprints near a desk holding a laptop and a hardhat..
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Given the changes in the job market, namely the decrease in the number of employers hiring full-time workers, it's important to know the difference between accepting a position as an independent contractor and a position as a payroll employee.

There are federal and state laws that govern whether an individual is an employee or an independent contractor. Therefore, the type of employment you choose will have an impact on your rights as a member of the U.S. workforce.

Are You an Employee or an Independent Contractor?

In general, if you're an independent contractor, you are working for yourself, and the company is your client. You are responsible for paying your employment taxes, and you are not entitled to company-provided or government-mandated employee benefits (including medical and/or dental). You must also carefully track your income for tax reporting purposes since your clients will not be withholding federal and state taxes from your pay.

Under most circumstances, contractors aren't eligible for unemployment benefits, unless they form their own business entity and establish themselves on that entity’s payroll. The same holds true for traditional benefits like medical insurance and company 401k programs.

When You're an Employee

A worker is considered an employee if the employer controls what work will be done, how it will be done, and when it will be done. The employing company has the right to define, control, and manage these details, and any employees who refuse to abide by those guidelines may be terminated.

While the employees are on the company payroll, the employer withholds federal and state taxes, Social Security, and Medicare from their paychecks. Additionally, employees are provided with unemployment and workers' compensation insurance. Employees may be offered benefits, including paid sick leave, vacation, health insurance, and retirement plans, such as a company 401k.

When You're an Independent Contractor

In contrast, an independent contractor decides how and when the work will be done. The contractual obligation between you and the other company is project-based. The “employer” or contracting company cannot tell you to report to the office or dress a certain way unless the project or job demands it under special circumstances, which should then be spelled out in the independent contractor agreement. What is important is the end result, and how this is reached is up to the contractor.

Independent contractors typically set their hours and are paid as freelancers, either with a flat rate or a per-job rate. The duration of their work, their independent project deadlines, and the details of their pay are determined by a contract signed with their clients before the period of work begins.

Independent contractors are responsible for paying their taxes to the IRS and the state through a process of estimated quarterly taxes. Independent contractors are not entitled to benefits, including unemployment and workers' compensation, because they are not payroll employees of the company that hires them. They are also solely responsible for securing their own medical, dental, and long-term care insurance.

IRS Employee or Independent Contractor Rules

Behavioral

Does the company control or have the right to control what the worker does and how the worker does his or her job? For payroll employees, the answer is “yes.” For independent contractors, the answer is “no” unless otherwise spelled out in the independent contractor agreement.

Financial

Are the business aspects of the worker's job controlled by the payer? These include things such as how and when the worker is paid, whether expenses are reimbursed, whether paid vacation or sick leave is offered, who provides tools/supplies, etc. Payroll employees can expect their employer to supply all of those things. However, independent contractors are expected to handle those details on their own.

Type of Relationship

Are there written contracts or employee type benefits (e.g., pension plan, insurance, vacation pay, etc.)? Will the relationship continue, and is the work performed a key aspect of the business? Any agreements in an independent contractor scenario will be outlined in a document literally entitled the “independent contractor agreement.”

State Laws

In addition to the federal guidelines, there are state laws regulating workers. Some states have more restrictive laws than the federal government. Check your state Department of Labor website for information on the rules in your location.

Pros and Cons

There are advantages and disadvantages to being either an employee or an independent contractor. Generally, this boils down to an issue of job security versus freedom. As an employee, you will enjoy benefits and (hopefully) the security of knowing that you will have steady employment for the foreseeable future, as long as the company continues to grow and you abide by employee guidelines.

However, you will probably also have to conform to the work schedules, possible overtime requirements, and work settings specified by your employer. 

Independent contractors, on the other hand, have the freedom to decide when, how, and exactly how much they will work. If you have clients who aren't clear on the boundaries between contractors and employees, there are steps you can take to ensure you're treated fairly and appropriately.

Read the terms of your contract, whether the organization you work for is an employer or a client, to best be able to make informed decisions about your professional future. It is also best to consult an attorney regarding any ambiguity in your relationship with your employer/client.

 The information contained in this article is not legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law.