Employee vs. Independent Contractor

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For many individuals, at some point in their career, they may have to decide whether or not they want to work as an employee or an independent contractor. For employers, this can be an important decision also as there are numerous tax and regulatory obligations in place when having an employee that does not exist when hiring independent contractors. This article will lay out the difference for both sides when approaching the employee vs. independent contractor decision.

For Individuals

When approaching the employee vs. independent contractor for individuals there are pros and cons to be considered.

Pros

• Independent contractor positions often come with more flexibility in managing your time and the delivery of work.
• Individuals working as independent contractors can typically take on other clients and work if they have the capacity, allowing you to earn more money.
• The actual take-home pay is typically higher than an employee’s.

Cons

• You don’t typically have fringe benefits like health or retirement plans
• Typically withholdings for tax purposes are paid by the employee.
• Your final tax bill can be substantial so you have to set funds aside during the year.
• Many federal and state legislation protecting employees doesn’t apply so you can be terminated more easily.

The pros and the cons really balance out here, additional income and flexibility come with added costs and fewer protections for you. Ultimately the decision comes down to the arrangement you would prefer.

For Companies

Companies often prefer to have independent contractors over employees for many reasons as the costs and burdens on the company are limited.

Pros

• No need to withhold taxes and make remittances to the IRS for the individual.
• Health benefits and retirement plans don’t need to be funded.
• Regulatory legislation isn’t applicable in most cases so a company can work independent contractors as hard as they want.
• Independent contractors can be dismissed whenever a company wants, providing a great deal of flexibility in staffing.

Cons

• Being less devoted to the individual comes at the cost that the individual is also less committed to the company they are working for
• Independent contractors can leave for a better project or higher-paying role without any required notice

There is less balance here than for individuals here, with the overall pros for a company far outweighing the cons. For companies, the ideal situation is many independent contractors working with a select number of key employees that the company cannot afford to lose.

Tax Perspective

For companies, there are guidelines from the IRS that determine whether an individual is actually an independent contractor or an employee and this prevents many companies from simply recognizing any individual as an independent contractor. The IRS will look at numerous factors including whether the individual supplies their own tools & equipment, whether they control the hours they work, whether the work is temporary or permanent, and a host of other factors.

If the IRS decides a company has incorrectly classified an individual the costs to the company can be substantial. The company will often have to pay extensive back taxes and amounts they should have withheld (had the person been correctly recognized as an employee) and the interest and penalties that apply. If this happens a company can end up with a substantial tax bill.

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