There are many differences between contractors and employees defined by nuances and exceptions in the governing laws, tests, and definitions of these two types of workers. With the constant small tweaks and adjustments to laws and varying tests from different government agencies, it can be difficult to keep things straight.
Even so, it is incredibly important to have a classification process that puts policies in place for hiring and managing your independent workforce. Misclassifying an employee as an independent contractor can result in costly legal consequences that can be detrimental to your business.
Yes, classification can be complicated, but here are 10 primary differences between independent contractors and employees that can help your business stay compliant.
What is a W-2 Employee?
Typically, a full-time employee works for a single employer and the employer dictates and controls the work performed as well as the hours and location of work. The employee is also entitled to legal benefits of a W-2 employee.
What is a 1099 Contractor?
Typically, an independent contractor operates as an independent business and may perform work for multiple clients. The contractor submits an invoice for completed work and provides their own tools and equipment. The independent contractor is responsible for both the individual and employer side of taxes.
Self-employment is now a viable career option for more people than ever before, and more companies are seeing the benefits of engaging independents vs employees.
Enterprises need the flexibility independent contractors can provide and their skillsets are in high demand. Independent talent can give businesses a cutting edge by providing on-demand expertise, financial savings, and staffing flexibility.
However, as the use of independent talent grows, businesses must also adjust the way they manage their workforce—compliance goes hand-in-hand with independent contractor engagement. Without proper management of independent contractors, you can run the risk of worker misclassification, which can lead to audits, fines, penalties, lawsuits, and more.
1099 vs W-2 Employee: 10 Key Differences Employers Need to Know
1. Contractors are business owners
As small business owners, independent contractors may be sole proprietors, or have an incorporated business. They have built these businesses around specialized services they provide—it’s not uncommon for independents to have a business name and perform work for multiple clients.
Think of your relationship with a 1099 worker as a business-to-business relationship. It can be easy to fall into the trap of treating them like an employee, but doing so can put you at risk for misclassification.
2. Contractors are specialized experts
While employees typically receive some sort of training surrounding their job duties, independent contractors bring specialized expertise to a project or task. As a client, you’re not responsible for providing them with training—pretty nice, right? Independent talent can be a great way to fill business needs.
While independents come from and work in virtually every sector of the economy, most demonstrate a high level of specialization in their industry. In fact, the majority of 1099 workers say they get work assignments because they offer a specialized skill that requires certification, special training, or education.
3. Contractors may have multiple clients
Remember, because independent contractors are running their own small business, they need to sell and market their services. Just because they have a long-term contract with you doesn’t mean they aren’t allowed to take on additional work for other clients as well.
4. Contractors perform specific tasks
Unlike traditional employees whose jobs may encompass a wide variety of duties and tasks, independent contractors are only responsible for performing the services outlined in a contract or Scope of Work (SOW).
The importance of an SOW
A clear SOW provides the foundation for a good working relationship, outlining the expectations of both parties. It should include details about the work to be done, a time frame, a process for managing changes, and payment terms.
5. Contractors submit invoices
Rather than working for a specific salary, independent contractors get paid by submitting invoices for their work. Pay and payment terms should be discussed during initial contract negotiations.
Independent contractors may have a standard billing rate for their services, or their rate may vary depending on the type of work you are looking for. Be sure to discuss how and when you’d like the contractor to invoice you for work completed, as well as how and when you will pay them after receiving an invoice.
6. Contractors set their own hours
Because independent contractors are their own business entity and are self-employed, a client cannot determine their work hours. They alone are responsible for fulfilling the work agreement—when they work and the hours they keep are completely up to them.
7. Contractors control how they work
While employees typically receive instructional oversight from a manager, a client cannot determine how an independent contractor works. For example, independents typically provide any needed tools or equipment.
If a project requires specialized equipment that is only available on site, this should be stipulated in a contract. If an independent contractor does need to work on site, ensure relevant company managers and employees are aware of processes and protocols so they do not treat the contractor like an employee.
8. Contractors pay their own taxes
When it comes to taxes, clients will typically complete Form W-9 to request the correct name and Taxpayer Identification Number (TIN) of the independent contractor they engage, and Form 1099-MISC, to report payments made. As a client, you don’t have to worry about withholding taxes for contractors you engage. Independents should be aware of their own tax responsibilities. They pay what’s known as self-employment (SE) tax, which includes both the employer and employee halves of Social Security and Medicare (FICA).
9. Contractors have their own benefit plans
There are many financial benefits to engaging independent contractors, including not having to provide traditional benefits such as health insurance, stock options, or retirement plans.
Understanding the legal side
Independents also do not receive the same legal protections—unemployment, anti-discrimination, and Workers’ Compensation—as employees. Nevertheless, it is good practice to ensure independent contractors have basic insurance requirements built into their contract to protect against any legal issues.
10. Contractors may work with other contractors
Independents may have their own employees, subcontractors, or partner consultants who help them to complete work tasks. During initial discussions, ask the independent contractor you are engaging if they utilize additional work resources. If they do, this should be outlined in your contract along with any necessary details. Remember, if independents do engage extra resources, they alone are responsible for the tax responsibilities, and filing and reporting requirements for these workers.
How to engage contractors compliantly
Partnering with an experienced firm can help you navigate complex classification processes and procedures. MBO Partners has extensive experience in helping organizations compliantly engage independent talent.
The information provided in the MBO Blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO Blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.