Which Is Better: Employee Or Independent Contractor?
An associate recently picked up and moved her life across the country to take a job with a start-up company. Though the move was risky, the ability was too amazing to give up. Cliff Davis Tampa FL
Initially she was hired as a full-time employee, but eight months later, the organization changed her role compared to that of an independent contractor. For me, this raised two questions: Is it better for a worker to speculate as an independent contractor or possibly a regular employee? And why might a manager 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 in relation to their compensation, benefits and relationships on their employers. Section 530 of the Revenue Act of 1978 laid your initial groundwork for the regulations we follow today.
In the 1960s and early 1970s, there was a growing concern money for hard times of the Social Security program. Some blamed the funding issue on independent contractors skimping on self-employment tax. This perception led to an increase in audits by the Internal Revenue Service. This, therefore, led to criticism 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 government from retroactively reclassifying independent contractors as employees. Section 530 protected employers from large penalties and back taxes after they met the law's standards.
To ensure employers to be eligible for a safe harbor under Section 530, the IRS required: a reasonable grounds for treating the workers as independent contractors; consistency in the manner 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 that audit issue of the '60s and '70s, it took over as 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, plus the rules of safe harbor availability as well as the question of who holds the burden of proof for classifications.
Many employers utilize the following rule of thumb to distinguish between a contractor and an employee: If an employer has the right to control the means by which the worker performs his / her services and the ends that work well produces, the worker is regarded as an employee. In 1987, the government released a 20-factor list, based on prior cases and rulings, to aid employers resolve some of the "gray areas" that this rule won't resolve. Some of the factors included on the list were: training; set hours of training; payment by the hour, week or month; furnishing tools or materials; carrying out work on the employer's premises; and payment of economic expenses.
For example, in the event 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 qualify as an employee. Similarly, in the event the employer requests the worker be on site with 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 of these factors is that a business has the right to control how a staff produces his or her work. When employing an independent contractor, the employer gives up this control. Independent contractors have a strong focus on the end result, not the process to accomplish the project. Overall, the IRS' 20-factor list helped many employers produce a baseline to evaluate the role of their hires and avoid misclassification.
In 1996, the internal revenue service took the list a measure further by identifying three broad groups of evidence to be used in discriminating between a staff member and an independent contractor. The three categories are behavioral control, financial control and relationship in the parties. In general, employers are only able to minimally regulate contractors' behavior. Contractors have the freedom to subcontract the work they receive, complete the task 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, how much time and energy contractors expend around the work they produce is up to the contractors, not their employers. As opposed, employees are typically paid per hour wage or a salary, which their employers monitor and control, with the number of hours worked. Employees could also receive additional benefits, such as health coverage or retirement plans, which independent contractors tend not to receive.
The third category, relationship in the parties, refers to the increasing practice of employers requiring employees to sign non-compete clauses or non-disclosure agreements. Generally, independent contractors are not required to sign such legal contracts. Contractors can function with multiple employers if they so choose - even competing employers. A company does not have the right to control the relationships an independent contractor may develop away from their work for that particular employer.
The legal distinction employees and contractors is obvious. Why, then, would a staff or an employer prefer one situation in the other? There is no right or wrong answer when it comes to a contractor or employee role, merely preferences for each and every situation.
An independent contractor enjoys more flexibility when compared to a full-time employee. The contractor can essentially be their own boss, by developing their own schedule, working without close supervision, and dealing with as heavy or light a workload because he sees fit. This allows open-ended earnings potential. Doing work for multiple employers also gives contractors more job security in one sense, because one employer breaking the bank or cutting back on staff will not destroy the contractor's whole stream of income. For an employee, conversely, it may be more appealing to possess a predictable schedule, the chance for advancement, along with a more stable income flow.
From an employer's perspective, an impartial contractor may be a good fit in the event the employer does not have the time or manpower to pay, monitor or make use of an employee full time. The business may simply need you to definitely complete projects with an occasional basis. On the other hand, if an employer would rather maintain close supervision as well as a worker who is on a regular and predictable basis, and when the employer has the means to pay the worker a reliable salary or hourly wage, then hiring the worker as an employee would be a more logical decision.
Employers and workers should also weigh factors like taxes, health care and retirement benefits within their decisions. When hiring an independent contractor, the employer does not pay the worker's taxes; rather, independent contractors have the effect of paying the tax themselves with the self-employment tax on Schedule SE, which takes care of their Medicare and Social Security tax. An employer withholds the equivalent tax from a worker's paycheck. Contractors can deduct the employer-equivalent area of the self-employment tax when calculating their adjusted revenues. However, this deduction only affects taxation, not self-employment tax. All self-employment salary is then reported on Schedule C.
Generally, employers are accountable for providing a 1099 form to contractors for his or her income reporting on Schedule C, specifically for income amounts over $600. However, the duty falls on the contractor to maintain accurate records, whether or not they received the tax forms or proper documentation. Independent contractors must also be conscious of making estimated tax payments all through the year, 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 utilize 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 knowledge on Schedule C of Form 1040. Employees sometimes incur unreimbursed business expenses too, such as for tools or union dues. Employees get less favorable treatment, handling such expenses as miscellaneous itemized deductions on Schedule A. Most such expenses are deductible provided that they exceed 2 percent with the employee's adjusted revenues. Overall, independent contractors face a much more complex tax situation, even when it is sometimes more favorable.
The current passage of the Affordable Care Act raised concern and uncertainty regarding which insurance and care programs will likely be available to independent contractors as well as to those seeking individual coverage. Natural meats see a change, too, with what options employers will give you for their employees down the road, particularly within company-sponsored group plans. The complication and uncertainty of the new health care landscape will take 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 just as one employee on their retirement planning. Many employers provide access to 401(k) plans or profit sharing plans, which assist employees in saving for their retirement (in addition to 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 also that they follow regulations include them as contributing properly. Otherwise, they may end up paying penalties for overcontributing or causing the wrong type of account, based on their income levels.
Thinking about the pros and cons of each kind of work, I come back to my original question. Maybe it was better for my friend to wind up as an independent contractor as opposed to an employee? Maybe. The progres offered her flexible working hours, less supervision and the opportunity to contract with other companies, with the resulting possibility of additional income. In exchange, she lost a well balanced salary, as well as her health insurance retirement benefits. On your own who can say when the trade was worthwhile is my good friend. As for why the start-up company preferred her being a contractor, I can only speculate. My instincts repeat the primary factor was probably cost. By cutting health insurance and retirement benefits and paying her piecemeal, they'll likely save money, allowing them to put more funds into the young firm. Cliff Davis Tampa FL