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Independent Contractor vs Employee: The Differences to Know

The US Bureau of Labor Statistics estimates that there are an estimated 15.5 million US workers who are independent contractors or have other alternative employee designations.

These statistics roughly translate into 1 in 10 workers that have an independent contractor status.

As more companies follow this flexible employment model, it’s important to know how to treat these kinds of employees differently than your regular employees.

One important difference is how to pay an independent contractor vs employee.

These two employee models are not alike. Read further so you can find and compensate the right employee that matches your firm.

What is an Independent Contractor?

An independent contractor is in business for themselves. When a company hires contractors, they are basically paying contractors to perform services using their own resources on their own time.

Independent contractors are employees who provide services on a contract basis. Independent contractors can also work on an as-needed basis rather than on set working hours.

There is also no commitment to hire the independent contractor once their task is done.

Independent contractors are business people. Therefore, if you hire one of these contractors, you are paying them a fee to perform specific services for you using their own resources on their own time.

What is a Permanent Employee?

A permanent employee must work on a preset schedule and at a specific location. Independent contractors are only paid for the work they actually do.

Permanent employees, by contrast, are paid regardless of productivity or work completed. Permanent employees enjoy a more stable work arrangement.

For example, permanent employees are entitled to workplace benefits, like overtime pay, health insurance, and enrollment to 401(k) plans.

Independent Contractor vs Employee Further Defined

Here is a further breakdown on the differences between these types of employees in each of these categories of employment considerations:

Control Over Work Conditions

The level of where, when, and how work gets done is different with an employee vs an independent contractor. IRS regulations as well as business settings dictate what level of control you have over independent contractors and regular employees.

If you’re working with an independent contractor, you care what the end product should look like and when it’s due. And that’s it.

One of the benefits of self-employment means the details of completing the work are up to the contractor as long as they complete the work to your satisfaction.

These “details” might include costs associated with licensing fees. These details could also range from what the independent contractor pays for worker compensation insurance for self employed to what they pay for home office utility costs.

All of these additional details are the contractor’s “cost to do business.”

When you work with a permanent employee, you exert more power on the details on how and when work gets done.

This includes requiring when employees come to the office to work and how long they work with the rest of your team. If you exert too much power, you might run into investigations with the US Department of Labor.

Paying Taxes

If a company hires permanent employees, that company deducts taxes from their paychecks. When a company is hiring independent contractors, the company pays the contractor in full per the terms of their agreement.

Companies that hire independent contractors won’t withhold Social Security, Medicare, or other federal taxes like they will for their regular employees. Independent contractors must meet those specific IRS regulations.

Independent contractors pay what’s called self-employment taxes. The portions of their paycheck that would normally be withheld by employers are instead directly paid to the contractor.

Then the contractor must pay those tax amounts themselves. Self-employment tax rates are around 15 percent.

This rate covers personal expenses for the contractor such as Medicare and Social Security. It’s the contractor’s responsibility to ensure that they reserve enough money for these taxes because it won’t be deducted by their employer who is really their client.

Independent contractors remit their taxes on their own using a federal form called a Form W-9. This W9 form lets the IRS know that the contractor is responsible for paying their own federal taxes, not the client.

Companies that are paying contractors will submit their own 1099 MISC tax form that matches the contractor’s filing.

Payment For Services/Work Performed

Permanent employees receive their paychecks based on either a salary or the number of hours worked. A salary is an annual amount, not dependent on productivity or time spent on a project.

An hourly wage is an amount paid based on the number of hours worked per work at a determined rate.

Expected Work Level Conditions 

There are some work situations where hiring an Independent contractor might be a smarter solution than hiring a permanent employee. If you have a short-term project, like a website redesign or a new product launch, a temporary contractor may be all you need.

Do you need specialized expertise outside of your primary business model? If you do, hiring these types of employees on a temporary basis might be wise.

They’ll bring specialized expertise to the table that you won’t need to directly supervise at every step. This can be a good solution if the work you need to be done is out of your area of expertise.

You should consider using permanent employees if the work is ongoing and central to your company’s purpose.

There is an advantage to having a workforce on hand that you don’t have to “bring up to speed” before each new project. Using a permanent team could be more time and cost-effective in the long run.

What Are Your Next Steps?

If you have a short-term project that’s outside of your core business portfolio of services, hiring an independent contractor may be best.

Talk to a tax accountant about how to pay contractors. They can advise you further on how to fulfill your 1099 MISC tax form obligations.

Meet with your contractors before work begins, to agree upon payment methods and schedules.

You can also check our website for more background on the question of whether to hire an independent contractor vs employee. Let us help you protect the business you’ve worked so hard to build.

Read Also: How to Pay Employees: The Basics Explained

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