Independent contractors vs employees: What do you need to know to make the right choice?
With more and more companies around the world realizing the benefits of adopting the remote work model at least partially, one thing holds true.
It is not unusual for job seekers to wonder whether to work remotely as an employee or as an independent contractor. Well, both options have their own advantages and disadvantages, and even employers sometimes struggle to make a choice between the two.
However, it gets easy if you understand what each option brings to the table, from the nature of the contract to payment terms, flexibility, tax obligations, and more.
Below are five clear-cut differences between an employee and an independent contractor that you should know about.
Independent Contractors vs Employee: 6 Key Differences
1. The Definitions
- Employee – An employee is someone who works solely for an employer, either in a full-time or part-time capacity, as outlined in the legally-binding employment contract signed between the two. The employer, who is mostly a business entity, often dictates the work location, hours of work, and the work performed. On top of their regular wage, employees are also entitled to certain benefits as required by labor and employment laws.
- Independent Contractor – An independent contractor is an individual or business that works independently to provide certain services or complete certain tasks for one or several clients based on certain agreed terms and conditions. In other words, an IC is a self-employed individual. Rather than waiting to be paid their wages, independent contractors usually send an invoice to the client once a project is complete or a certain threshold is met.
2. Remuneration Terms Differ
An employee’s remuneration comes in the form of wages or salaries. These can be made periodically, say weekly, fortnightly, or monthly. Also, the salary could either be a fixed, constant figure or a total of the hours worked based on a specified hourly rate. Payments are usually made by payroll, usually on a specified day of the week or date of the month.
In contrast, an independent contractor earns income from each project or task completed. This means that they can earn less or more depending on the availability of work, productivity, and resources.
In most businesses, payments for independent contractors are drawn from the Accounts Payable department rather than payroll. The statement of work or contract document between the client and the contractor usually determines the schedule and frequency of payments.
3. Tax Obligations
Every employed individual is required by law to pay income tax. Luckily, most employers do this for their staff by withholding income tax, alongside Medicare and social security from paid wages. This is to say that as an employee, your take-home paycheck is less with a certain percentage that goes to income tax and other statutory deductions.
For independent contractors, the client or company doesn’t usually withhold taxes. However, contractors are still required to pay income tax as well as self-employment tax, which usually caters to Social Security taxes and Medicare.
Independent contractors are usually responsible for their tax obligations, which may vary depending on whether the business made a net profit or net loss. Typically, independent contractors who make a minimum of $400 in net profit are required to file annual tax returns with the IRS.
4. Independent Contractors Should Receive a 1099-NEC for Income Over $600
Businesses are not required to withhold income tax from independent contractors. However, the IRS requires payments made to non-employees for the year to be reported to the taxman if they were more than $600.
From 2020, this will be done using a form known as 1099-NEC. Businesses simply have to download a printable 1099-NEC form online, fill in the details, and file the duly filled form with the IRS. A copy of the same should also be sent to the contractor so they can use it to prepare their tax return.
Many independent contractors also use Form 1040-ES to make quarterly tax estimates, so they can avoid huge tax bills at the end of the year.
5. An Employee May Receive Training and Other Benefits
From medical insurance to retirement pension, life insurance, and paid time off, being an employee may attract a wide range of benefits. As part of the onboarding process, many employers will often ensure an employee receives proper training once they are hired.
On the other hand, independent contractors have to pay for the aforementioned benefits out of pocket. They are usually given just enough information to help them best deliver on a specific task or project. After all, they are usually hired based on their expertise, experience, or skill set that the business or client may only require for a temporary period.
6. Independent Contractors Bear On-The-Job Expenses
The expenses incurred on the job by an employee are usually covered by their employer. Conversely, an independent contractor is usually responsible for most if not all the expenses incurred during service provision. Oftentimes, they also have to bear the costs of equipment, materials, tools, and other resources required to perform the task at hand.
To Wrap Up on
Making a choice between working as an employee or an independent contractor can be a tough call. However, each option has its own set of pros and cons, and your choice may largely depend on what you value most. Understanding the differences between the two can help you make an informed decision.