Employees vs. Independent Contractors: What’s the Difference?
Hiring seems like it should be straightforward – someone does work, you give them money, right? Unfortunately, it’s not so simple. In our experience, employee classification is among the most misunderstood aspects of running a business.
Workers, when hired, fall into two main categories: Employees and Independent Contractors. These are completely separate classifications – an independent contractor cannot also be an employee, and vice versa. Most government agencies specify how to classify your workers. If a company doesn’t follow this guidance, they can face costly back-taxes, interest, fines, penalties, and lawsuits. Avoid the headache. Classify your workers correctly.
How do I know which kind I have?
This is a confusing and subjective judgment. So first off, we recommend you read our full write-up on How to Determine Worker Classification, but keep reading for a quick overview.
The Illinois Department of Employment Security assumes by default that anyone performing services for a company is an employee, unless their employment meets all three of the following criteria:
- the individual can perform their services free from “control or direction” of the company (typically, they set their own hours, aren’t given any instruction manuals, use their own equipment, and so on);
- the service performed is outside the usual suite of company services (for example, an app-building company could hire an accountant as an independent contractor, but probably not a programmer), and;
- the individual is engaged in an independently established trade, occupation, profession, or business (they have their own company, are free to work for other people, etc.).
The Internal Revenue Service focuses more on the worker’s degree of operational freedom. In general, the more a company controls a worker’s services, the more likely they should be classified as an employee.
When in doubt, cover your bases and classify your workers as employees. This will help avoid some serious ramifications (more on those below).
What are the practical differences?
As with the above determination, the nuances that separate employees from contractors are many. And wouldn’t you know it, we wrote a full post about How to Treat Employees vs. Independent Contractors! Click over there for more details; keep reading for a summary of the differences.
- Taxes: Companies are required to withhold various taxes from employee wages, but not for independent contractors. The independent contractor is considered self-employed, so they are responsible for their own taxes.
- Control: Employers can dictate as much or as little of an employee’s job as they want, but should limit control over independent contractors’ work. In general, do not dictate hours for independent contractors, do not provide training, and do not give them manuals or employee handbooks.
- Laws: There are many, many laws an employer must follow regarding their employees. Fewer pertain to independent contractors. Contact an attorney to review the laws that are applicable to your business.
- Contracts: It’s important for businesses to enter into contracts with their independent contractors, and much less so for employees.
What are the consequences of misclassification?
This is a serious topic. For full understanding, read our complete breakdown of the ramifications.
If you’re caught misclassifying workers by an IRS or IDES audit, or if a worker sues you and triggers an investigation, you could face steep fines and penalties. State and federal governments can and will issue fines to employers who misclassified their workers. Did you fail to report payroll taxes? Do you lack the appropriate documentation for your employees? Did you leave the employer’s share of Social Security and Medicare unpaid? All of these could lead to financial and logistical pain.
You could also be on the hook for back pay and benefits for a misclassified employee. For example, if the employee should have received Paid Time Off, paid rest time, and health coverage, they can seek restitution from their employer for the time they were misclassified.
Caught in an audit? Do you want to transition your contractors to employees? We can help with that! Contact us today.