Keep reading to learn more about how employees are defined, and how they differ from independent contractors.
What Is an Employee?
An employee is hired for a specific job or to provide labor in the service of someone else (the employer). When an individual begins a long-term working relationship with a business, that person usually becomes an employee, though there are exceptions. The Internal Revenue Service (IRS) sets the guidelines for determining which workers are employees.
How Do Employees Work?
It’s important for both the employee and employer to understand exactly what an employee is. Employees have special protections, as well as certain obligations, compared to other kinds of workers. Conversely, an employer usually has more control over its employees, but it also has tax obligations to meet on the employee’s behalf. When an employer determines that its workers are employees, it must withhold federal and state income taxes from those people’s paychecks. The employer must also pay half of each employee’s FICA taxes, which go toward Social Security and Medicare benefits. Businesses often think about tax implications when deciding between hiring an employee or non-employee. It’s legal to consider these factors, but it’s illegal to simply reclassify an employee as a contractor to avoid paying taxes. If a business improperly classifies workers as independent contractors, and the IRS or a state agency investigates, the business could be held liable for back taxes and financial penalties.
Employees vs. Contractors
For example, if you work as a graphic designer for a company on a per-project basis, you are an independent contractor, not an employee. The IRS has an intricate system of determining the proper classification for a worker, but most businesses and workers can make the determination themselves. The IRS has common law rules to help guide those determinations. The common laws are broadly broken down into three categories: behavioral factors, financial factors, and the type of relationship.
Behavioral Factors
An employer has greater control over the behavior of its employees compared to its contractors. If the worker is an employee, the employer can tell that employee exactly when, where, and how to complete the work. If the worker is a contractor, the employer can only control the delivery of the final project—they can detail what they want and when they want it, but that’s it. Evaluations of a contractor can only discuss the end result of the contractor’s efforts. Evaluations of an employee can include work habits, conduct, and any other details about how the work is performed.
Financial Factors
Employees are more likely to be reimbursed for any costs they incur while working. However, many employees have some form of unreimbursed cost, like the gas it takes to drive to work. There isn’t a specified limit for how much cost a worker can personally take on before they become a contractor. As a general rule of thumb, the more of your own money you put toward buying supplies and equipment, the more likely you are to be a contractor rather than an employee. Another financial factor is the method of payment. An employee is guaranteed a set wage over a certain time, such as hourly pay or annual salary. A contractor may be paid hourly, or they may be paid a flat fee for a service.
Type of Relationship
The type of relationship refers to the contracts, timelines, and benefits that come with employment. There’s a lot of fluidity with these factors. For example, employees are more likely to get benefits like pension plans and vacation pay, but these benefits may be extended to a contractor, as well. Offering vacation pay, in and of itself, doesn’t make a worker an employee. Similarly, employees are more likely to have long-term relationships with their employers, but contractors can have long-term relationships, too.
State Determinations
Some states have stricter laws designating worker classifications. They use variations of an ABC Test that restricts calling someone an independent contractor unless they meet specific criteria. Check your state’s guidelines before determining employment status.
