Are you looking to expand your business or venture down a path to self-employment? Can’t decide between hiring employees and contracting a third-party for help? This post includes the key facts you may need to consider.
Who are you looking for?
Independent contracting is defined by the IRS as, “the payer has the right to control or direct only the result of the work and not what and how the work will be done. The earnings of the person working as an independent contractor is also subject to Self-Employment Tax.”
On the IRS website, an employee is a person that is controlled by you in regards to what work will be done and how the work will be done.
These definitions can sometimes be unclear, so Common Law Rules are used.What are the Common Law Rules? IRS.gov also mentions some Common Law Rules that are the deciding factors on control and independence.
Behavior. A worker is an employee when the business has the right to direct and control the activities of the worker. Therefore, if the employer makes determinations as to the direction and control of the work, the person is more likely to be considered as an employee. Direction and control includes if an employer gives instructions on when the work will be performed, where the work will be performed, what tools the worker will use, what order or sequence to follow when performing the work, and what other workers may be hired to assist with the work. On the job training is also a strong indicator that a worker is an employee. Independent contractors usually use their own methods and tools to complete the work.
Financial control. This involves a question of if the business has the right to control the economic aspects of the worker’s job. An independent contractor often has a major investment in equipment used in services for others. However, a significant investment is not necessarily a sign that a worker is an independent contractor. The opportunity for profit or loss is a very important factor. Having the possibility to incur a loss is an indicator the worker is an independent contractor. There are occurrences where expenses may exceed their income from the work. An independent contractor is free to seek out other business opportunities. Also, the method of payment is often a major indicator of an employee versus an independent contractor. An employee is guaranteed a regular hourly wage or a salary for the work they perform. An independent contractor is usually paid a flat fee for the job. However, in some professions such as law, contractors can be paid hourly.
Type of Relationship. The relationship between two parties generally falls into the categories of written contracts, employee benefits, permanency of the relationship, and services provided as key activities considered under the law. However, the IRS is not required to follow a contract stating that a worker is an independent contractor. It is determined by how the parties work together. Benefits are not granted to contractors. However, a lack of benefits does not mean the worker is an independent contractor. Benefits vary by companies. In addition, if you hire a worker with the expectation that the relationship will continue indefinitely, this is evidence there may be an employer-employee relationship. Independent contractors usually work for a specific project or period. Thus, why contracts are helpful in determining the work an independent contractor will perform.
Pros and Cons
Independent contractors have to pay their own Social Security and Medicare taxes and health insurance. Employees share this tax with their employer. However, contractors quality for tax deductibles in the performance of their work, which is an advantage. Employees hold the advantage of a stable income.
Employees have the advantage when it comes to taxes. Employers pay 50% of your social security and Medicare taxes. Independent contractors have to pay for those taxes on their own. The Self-employment tax is (15.3%) of your earnings. This tax consists of 12.4% Social Security tax & 2.9% Medicare tax. Contractors must pay and file a Form 1040 if they earn $400 or more. Contact a tax preparer to learn more about how to set aside money to pay these taxes so you will not owe the IRS.
Worker’s Compensation: Protect your business from civil suits
Worker’s compensation is a form of insurance that provides wage replacement benefits, death benefits, medical treatment, vocational rehabilitation, and other benefits to employees injured in the course of employment. Each state establishes laws governing worker’s compensation. Independent contractors are not eligible for worker’s compensation coverage because they are not employees. However, some independent contractors purchase their own insurance. This is more common with construction workers.