John Gregory, President, 1040Return.com
The businesses’ need to cut back on costs and achieve higher operating efficiency has made the idea of hiring independent contractors more lucrative with every passing day. While most professionals finish the task, get paid and never think about it until the tax time is around the corner, there are businesses that misclassify their workers erroneously due to the complex nature of tax laws or deliberately to save on additional employment costs. Such misclassification can have a deep and negative impact on your business, both financial as well as reputational.
Difference between Contract Employees and W-2 Employees
In order to be able to distinguish the people working for you into the two categories, it is necessary that you understand the difference between the W-2 employee and an independent contractor. Let us take a look at the important characteristics of an employee and a contractor that will help you tell them apart.
- Withholding the Taxes
This is one of the major differences between the W-2 income and self-employed income. When you are hiring an employee, you shall withhold their taxes by deducting a portion from their paycheck. In simpler words, you will pay their taxes on their behalf. You will issue your employees a W-2 form at the end of the year. It mentions their income and the amount withheld for the purpose of paying off the federal and state taxes. You will need to submit a copy of it to the IRS as well.
On the other hand if you are hiring an independent contractor, you are not supposed to withhold their taxes. Since the independent contractors do not have an employer, the responsibility of computing and paying their own taxes falls upon them. As a client you shall provide them with a 1099-MISC form and shall submit a copy of the same to the IRS, to report the amount you have paid them for their services.
- Control in the Watchword
If you exercise strict control over the methods of working and number of working hours of your workers, and if they are expected to follow the workplace protocols and the code of conduct, they certainly are your employees. An independent contractor is just concerned with completing the assignment according to the guidelines within the agreed time limit and getting compensated for the same. The company they work for does not monitor their working hours or how they get the task done. Independent contractors are their own boss.
- Number of People You Work For
It is quite obvious that an employee can work only for one employer. Independent contractors can take up multiple assignments and provide their services to multiple clients, simultaneously.
- Place of Work
Employees need to work from employer’s premises aka the office. Independent contractors may or may not need to work from their client’s premises, depending upon the nature of work. For example, an independent interior decorator will need to be working at their client’s premises in order to give it a face-lift. On the contrary, an independent medical biller/medical coder can do their job remotely from the comfort of their home via the internet. Moreover as opposed to employees, independent contractors have their own set of tools and resources that they put in for completing their jobs.
Employers make sure that their employees remain at the top of their game at all times. Hence they provide training to their employees, so that it works in their best interest. Such scenarios do not usually occur in case of independent contractors. They are not provided any training by their clients. They are specialists and self-taught workers. If at all they need training, they seek it from other sources, such as a crash course or coaching class. However, employees always get their training from the employers when they need to develop new skills as the newer, more challenging projects come in.
- Entitlement to Benefits
Usually it is said that the best part about being an employee is that you are entitled to the benefits offered under the course of employment; such as 401k, paid sick leaves, health insurance, etc. Individual contractors are certainly not entitled to any of the aforesaid benefits. Their clients may just reward them in the form of bonus for their exceptional services at their own discretion.
The IRS has been taking strict action against the businesses that misclassify their employees to save on the cost of employment. If you feel you have erroneously misclassified your employees as contractors or vice-versa and in order for the IRS to assist you in establishing the actual status of your workers, you can file Form SS-8 which is a request to establish if your firm has an employee or an independent contractor.
About the Author
John Gregory is the president of 1040Return.com, a tax consultant and an Enrolled Agent in Baltimore, Maryland, a federally authorized tax practitioner who has technical expertise in the field of taxation. He is empowered by the U.S. Department of the Treasury to represent taxpayers before all administrative levels of the Internal Revenue Service for audits, collections, and appeals. For more information, visit the site: http://1040return.com/.