Which Is Better: Employee Or Independent Contractor?
Which Is Better: Employee Or Independent Contractor?
A friend recently picked up and moved her lifetime across the country to take work with a start-up company. Though the move was risky, the chance was too amazing to give up.
Initially she was hired like a full-time employee, but eight months later, the organization changed her role fot it of an independent contractor. For me, this raised two questions: Could it be better for a worker to invest as an independent contractor or a regular employee? And why might a business choose one over the other?
In the last 40 years, Congress has transpired several laws that outline the distinctions between employees and independent contractors with regards 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.
Within the 1960s and early 1970s, there is a growing concern for the future of the Social Security program. Some blamed the funding issue on independent contractors skimping on self-employment tax. This belief led to an increase in audits from the Internal Revenue Service. This, consequently, led to criticism that this IRS was too aggressive in classifying workers as employees, instead of as self-employed independent contractors, and that it applied its criteria inconsistently. Congress responded by enacting Section 530, providing safe harbor for employers by preventing the internal revenue service from retroactively reclassifying independent contractors as employees. Section 530 protected employers from large penalties and back taxes once they met the law's standards.
To ensure employers to be entitled to 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 anyone categorized as contractors. Though Section 530 was intended to be an interim measure for the audit issue of the '60s and '70s, it took over as the 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, along with the rules of safe harbor availability and the question of who sports ths burden of proof for classifications.
Many employers utilize following rule of thumb to differentiate between a contractor plus 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 considered an employee. In 1987, the IRS released a 20-factor list, according to prior cases and rulings, to help you employers resolve many of the "gray areas" that this rule will not resolve. Some of the factors included listed were: training; set hours of training; payment by the hour, week or month; furnishing tools or materials; working on the employer's premises; and payment of business expenses.
For example, if the employer requires the worker to pass through a training class before starting work, or to use particular tools or materials the business provides, the worker would grow to be an employee. Similarly, if your employer requests the worker be on site with the company headquarters from 8 a.m. in order to 5 p.m. daily, the worker is an employee, no independent contractor.
The overarching theme of these factors is that a business has the right to control how an employee produces his or her work. When hiring an independent contractor, the employer gives up this control. Independent contractors have a very strong focus on the outcome, not the process to perform the project. Overall, the IRS' 20-factor list helped many employers create a baseline to evaluate the role of their hires and prevent misclassification.
In 1996, the IRS took the list a measure further by identifying three broad kinds of evidence to be used in discriminating between a staff member and an independent contractor. A few categories are behavioral control, financial control and relationship with the parties. In general, employers is only able to minimally regulate contractors' behavior. Contractors are free of charge to subcontract the work they receive, complete the task in the way they feel is most efficient, and set their own hours and work location.
Financial control means that contractors' payment standard is based on a "per task" or "piece work" pay. Therefore, the amount of time and energy contractors expend around the work they produce can be the contractors, not their employers. In contrast, employees are typically paid a per hour wage or a salary, which their employers monitor and control, combined with number of hours worked. Employees may also receive additional benefits, such as health coverage or retirement plans, which independent contractors usually do not 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 certainly not required to sign such legal contracts. Contractors perform with multiple employers should they so choose - even competing employers. An employer does not have the right to control the relationships an unbiased contractor may develop outside their work for that particular employer.
The legal distinction employees and contractors is see-through. Why, then, would a staff member or an employer prefer one situation on the other? There is no correct or incorrect answer when it comes to a specialist 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 his own boss, by developing their own schedule, working without close supervision, and taking on as heavy or light a workload as they sees fit. This gives open-ended earnings potential. Being employed by 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 greenbacks. For an employee, on the other hand, it may be more appealing to experience a predictable schedule, the likelihood for advancement, plus a more stable income flow.
From an employer's perspective, an impartial contractor may be a good fit when the employer does not have the means or manpower to pay, monitor or readily employee full time. The employer may simply need someone to complete projects while on an occasional basis. In contrast, if an employer would rather maintain close supervision as well as a worker who is positioned on a regular and predictable basis, and if the employer has the methods to pay the worker a stable salary or hourly wage, then hiring the worker as an employee would be a more logical decision.
Employers and workers also needs to weigh factors like taxes, health care and retirement benefits inside their decisions. When hiring an independent contractor, the business does not pay the worker's taxes; rather, independent contractors are accountable for paying the tax themselves from the self-employment tax on Schedule SE, supplies their Medicare and Social Security tax. A manager 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 income tax, not self-employment tax. All self-employment income is then reported on Schedule C.
Generally, employers are accountable for providing a 1099 form to contractors for their income reporting on Schedule C, in particular for income amounts over $600. However, the burden falls on the contractor to maintain accurate records, no matter if they received the tax forms or proper documentation. Independent contractors must be conscious of making estimated tax payments throughout every season, which can be a challenge when income is not as steady as a possible employee's would be. And when they purchase equipment or materials, or use a home office for work, independent contractors must track their expenses to enable them to be deducted properly.
Independent contractors deduct their business expenses directly against their business receipts, reporting the info on Schedule C of Form 1040. Employees sometimes incur unreimbursed business expenses too, for example for tools or union dues. Employees get less favorable treatment, handling such expenses as miscellaneous itemized deductions on Plan a. Most such expenses are deductible only when they exceed 2 percent from the employee's adjusted income. Overall, independent contractors face a far more complex tax situation, even though it is sometimes more favorable.
The recent passage of the Affordable Care Act raised concern and uncertainty regarding which insurance and care programs will likely be available to independent contractors or those seeking individual coverage. We might see a change, too, of what options employers will provide for their employees later on, particularly within company-sponsored group plans. The complication and uncertainty of the new health care landscape is going to take some time to play out, for independent contractors and employees alike.
Additionally, workers must look into the impact of operating being an independent contractor or as an employee on their retirement planning. Many employers provide use of 401(k) plans or profit sharing plans, which assist employees in saving for their retirement (in addition to individual saving they may 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 make certain not only that they save enough, but additionally that they follow regulations and have contributing properly. Otherwise, they could end up paying penalties for overcontributing or contributing to the wrong type of account, depending on their income levels.
Thinking about the pros and cons of each type of work, I come back to my original question. Maybe it was better for my friend to end up as an independent contractor rather than an employee? Maybe. The change offered her flexible working hours, less supervision as well as the opportunity to contract with other programs, with the resulting prospect of additional income. In exchange, she lost a stable salary, as well as her health insurance and retirement benefits. Man or woman who can say if your trade was worthwhile is my buddy. As for why the start-up company preferred her like a contractor, I can only speculate. My instincts the primary factor was probably cost. By cutting health insurance retirement benefits and paying her piecemeal, they're going to likely save money, enabling them to put more funds back into the young firm.