Federal and state policies and statutes concerning the differences between independent contractors and employees are overly complex, which in part causes the misclassification of many employees as independent contractors. Generally, the following two tests are applied to properly determine the employment relationship.
“Right to Control” test
The “Right to Control” test focuses on the degree of control an employer exercises over a worker.
A worker is more likely to be an employee if the employer exhibits a high degree of control over the worker, such as directing when, where, and how the employee works. An employer also shows control by paying for the employee’s travel, equipment, and supplies.
A worker is more likely to be an independent contractor if the employer exhibits a low degree of control over the worker, who is considered to be “self-employed.” Although the employer has the right to direct the result of the work, the worker is free to work when, where, and how s/he chooses. An independent contractor also shows independence by typically paying for most or all business-related expenses.
“Economic Realities” test
The “Economic Realities” test focuses on the degree to which a worker is economically dependent on the employer’s business.
An employee typically has a high degree of economic dependence on the employer’s business. An employee is normally hired for a permanent position, and has a set schedule. The employee still works even if his services are needed irregularly or on a part-time basis.
An independent contractor typically has a low degree of economic dependence on the employer’s business. The independent contractor is hired by project, on a temporary basis and generally sets his/her own schedule. The independent contractor has a defined relationship that usually ends when the services for that project are completed, and s/he typically works on projects at several businesses simultaneously, including competing businesses.
Difference in Wages and Tax Status
Even if employees and independent contractors do similar work, the Internal Revenue Service holds these workers and their employers accountable to different tax responsibilities.
The wages of an employee are subject to payroll tax withholdings, social security, Medicare, and unemployment insurance. Employees are given a W-2 statement at the end of the year that shows the amount of withholdings. Employees are also usually given a benefits package from their employer which may include health care, vacation and/or sick pay, and retirement benefits. Most hourly employees are entitled to be paid overtime compensation for hours they work beyond forty in any given week.
Independent contractors are subject to Self-Employment Tax and receive their pay without any withholdings taken. Independent Contractors are given a 1099 statement showing the income they received as a self-employed worker. Usually, Independent Contractors do not receive any benefits packages from the employer or overtime compensation.
The differences between an independent contractor and an employee amount to much more than a difference in name—and have an impact on the operations of a business and the livelihood of a worker. Some individuals prefer an independent contractor’s freedom to control their own schedule, while others value the benefits and stability of an employee-employer relationship. Either way, employers and workers alike should collaborate to ensure proper employment classification so that both parties can avoid any conflicts and mutually benefit from the relationship.