Which Is Better: Employee Or Independent Contractor?
An associate recently picked up and moved her lifetime across the country to take work with a start-up company. Though the move was risky, the ability was too amazing to feed up.
Initially she was hired being a full-time employee, but eight months later, the company changed her role to that of an independent contractor. For me, this raised two questions: Could it be better for a worker to get as an independent contractor or even a regular employee? And why might a business choose one over the other?
In the last 40 years, Congress has gone by several laws that outline the distinctions between employees and independent contractors with their compensation, benefits and relationships to their employers. Section 530 from the Revenue Act of 1978 laid your initial groundwork for the regulations we follow today.
Inside the 1960s and early 1970s, there was a growing concern in the future of the Social Security program. Some blamed the funding issue on independent contractors skimping on self-employment tax. This belief led to an increase in audits with the Internal Revenue Service. This, in turn, led to criticism how the IRS was too aggressive in classifying workers as employees, instead of as self-employed independent contractors, which applied its criteria inconsistently. Congress responded by enacting Section 530, providing safe harbor for employers by preventing the IRS from retroactively reclassifying independent contractors as employees. Section 530 protected employers from large penalties and back taxes if they met the law’s standards.
To ensure that employers to qualify for safe harbor under Section 530, the government required: a reasonable cause for treating the workers as independent contractors; consistency in terms such workers were treated; and proper tax reporting using 1099 forms for the people categorized as contractors. Though Section 530 was first intended to be an interim measure for the audit issue of the ’60s and ’70s, it had become the enduring baseline for today’s worker classification regulations. Subsequent legislation, such as the Small Business Job Protection Act of 1996, further clarified the word what in Section 530, along with the rules of safe harbor availability along with the question of who holds the burden of proof for classifications.
Many employers use the following rule of thumb to tell apart between a contractor as well as an employee: If an employer contains the right to control both means by which the worker performs his or her services and the ends that actually work produces, the worker is considered an employee. In 1987, the IRS released a 20-factor list, determined by prior cases and rulings, to help you employers resolve some of the “gray areas” that this rule will not resolve. Some of the factors included on the list were: training; set hours at work; payment by the hour, week or month; furnishing tools or materials; doing work on the employer’s premises; and payment of business expenses.
For example, if the employer requires the worker to go through a training class before starting work, or to use particular tools or materials the employer provides, the worker would become qualified as an employee. Similarly, if the employer requests the worker be on site on the company headquarters from 8 a.m. to p.m. on a daily basis, the worker is an employee, not an independent contractor.
The overarching theme coming from all these factors is that a manager has the right to control how an employee produces his or her work. When employing an independent contractor, the business gives up this control. Independent contractors have a very strong focus on the outcome, not the process to complete the project. Overall, the IRS’ 20-factor list helped many employers create a baseline to evaluate the function of their hires and prevent misclassification.
In 1996, the internal revenue service took the list one step further by identifying three broad categories of evidence to be used in discriminating between an employee and an independent contractor. These categories are behavioral control, financial control and relationship with the parties. In general, employers could only minimally regulate contractors’ behavior. Contractors have the freedom to subcontract the work they receive, complete the job in the way they feel is best, and set their own hours and work location.
Financial control implies that contractors’ payment standard is founded on a “per task” or “piece work” pay. Therefore, the amount of time and energy contractors expend around the work they produce can be the contractors, not their employers. As opposed, employees are typically paid a per hour wage or a salary, which their employers monitor and control, with the number of hours worked. Employees may also receive additional benefits, such as health coverage or retirement plans, which independent contractors usually do not receive.
The third category, relationship from the parties, refers to the increasing practice of employers requiring employees to sign non-compete clauses or non-disclosure agreements. Generally, independent contractors aren’t required to sign such legal contracts. Contractors can function with multiple employers if they so choose – even competing employers. A manager does not have the right to control the relationships a completely independent contractor may develop beyond their work for that particular employer.
The legal distinction employees and contractors is apparent. Why, then, would a staff or an employer prefer one situation in the other? There is no correct or incorrect answer when it comes to a specialist or employee role, merely preferences for each situation.
An independent contractor enjoys more flexibility compared to a full-time employee. The contractor can essentially be his own boss, by developing their own schedule, working without close supervision, and accepting as heavy or light a workload because he sees fit. This supplies open-ended earnings potential. Employed by multiple employers also gives contractors more tons of employment opportunities in one sense, because one employer going broke or cutting back on staff is not going to destroy the contractor’s whole stream of income. For an employee, conversely, it may be more appealing to have a predictable schedule, the chance for advancement, and a more stable income flow.
From an employer’s perspective, an independent contractor may be a good fit when the employer does not have the means or manpower to pay for, monitor or readily employee full time. The business may simply need someone to complete projects while on an occasional basis. In contrast, if an employer likes to maintain close supervision and needs a worker who is on a regular and predictable basis, of course, if the employer has the ways to pay the worker a reliable salary or hourly wage, then hiring the worker as an employee has to be more logical decision.
Employers and workers also needs to weigh factors for example taxes, health care and retirement benefits within their decisions. When employing an independent contractor, the employer does not pay the worker’s taxes; rather, independent contractors are responsible for paying the tax themselves through the self-employment tax on Schedule SE, which provides coverage for their Medicare and Social Security tax. A company withholds the equivalent tax from a worker’s paycheck. Contractors can deduct the employer-equivalent element of the self-employment tax when calculating their adjusted revenues. However, this deduction only affects taxation, not self-employment tax. All self-employment wages are then reported on Schedule C.
Generally, employers have the effect of providing a 1099 form to contractors for their income reporting on Schedule C, specifically for income amounts over $600. However, the responsibility falls on the contractor to hold accurate records, regardless of whether they received the tax forms or proper documentation. Independent contractors should also be conscious of making estimated tax payments throughout every season, which can be a challenge when salary is not as steady as a possible employee’s would be. And when they purchase equipment or materials, or make use of a home office for work, independent contractors must track their expenses to be able to be deducted properly.
Independent contractors deduct their business expenses directly against their business receipts, reporting the information on Schedule C of Form 1040. Employees sometimes incur unreimbursed business expenses too, for example for tools or union dues. Employees get less favorable treatment, handling such expenses as miscellaneous itemized deductions on Plan a. Most such expenses are deductible as long as they exceed 2 percent of the employee’s adjusted revenues. Overall, independent contractors face a far more complex tax situation, even when it is sometimes more favorable.
The present passage of the Affordable Care Act raised concern and uncertainty regarding which insurance and care programs will probably be available to independent contractors or to those seeking individual coverage. Organic beef see a change, too, in what options employers can provide for their employees in the foreseeable future, particularly within company-sponsored group plans. The complication and uncertainty from the new health care landscape will need some time to play out, for independent contractors and employees alike.
Additionally, workers should think about the impact of operating as an independent contractor or as an employee on their retirement planning. Many employers provide entry to 401(k) plans or profit sharing plans, which assist employees in preserving for their retirement (along with individual saving they will often pursue via IRA or Roth IRA accounts). Independent contractors should save for their retirement positioned on their own. Though certainly manageable, this arrangement places greater responsibility on independent contractors to ensure not only that they save enough, but in addition that they follow regulations to ensure they are contributing properly. Otherwise, they will often end up paying penalties for overcontributing or causing the wrong type of account, according to their income levels.
Considering the pros and cons of each kind of work, I resume my original question. Is it better for my friend to wind up as an independent contractor instead of an employee? Maybe. The progres offered her flexible work hours, less supervision as well as the opportunity to contract with other programs, with the resulting prospect of additional income. In exchange, she lost a reliable salary, as well as her health insurance and retirement benefits. On your own who can say in the event the trade was worthwhile is my pal. As for why the start-up company preferred her like a contractor, I can only speculate. My instincts say the primary factor was probably cost. By cutting health insurance retirement benefits and paying her piecemeal, they’ll likely save money, allowing them to put more funds back into the young firm.