Independent Contractor vs Employee: 10 Key Differences for Classifying Workers
Laws, tests, and definitions of what differentiates independent contractors from employees are full of nuances and exceptions. With the constant small tweaks and adjustments to laws and varying tests from different government agencies, it can be difficult to keep things straight.
Nevertheless, having a classification process that puts policies in place for hiring and managing your independent workforce is incredibly important. 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 main differences between independent contractors and employees that can help your business stay compliant.
10 Key differences between Contractors and Employees
1. Business ownership
Independent professionals 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 an independent contractor 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. Industry expertise
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 independents say they get work assignments because they offer a specialized skill that requires certification, special training, or education.
3. Open Marketing
Remember, because independent contractors are running their own 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. Time contrainsts
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). 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.
Rather than working for a specific salary, independent contractors submit 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.
Because independent contractors are their own business entity, a client cannot determine their work hours. They alone are responsible for fulfilling the work agreement—when they work and the hours they keep is completely up to them.
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.
When it comes to taxes, as a client you will typically complete Form W-9 to request the correct name and Taxpayer Identification Number (TIN) of the independent contractor, 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).
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.
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.
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.
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. Contact us today to learn more.
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.