On the face of it, the difference between a traditional employee and independent contractor may seem minimal, as oftentimes, employees and independent contractors work side by side, with little distinction or difference in job duties.
However, the differences between the two, carry substantial financial and legal personal benefits and consequences.
Understanding the differences, benefits, and consequences between the two could mean the difference between a continuing professional relationship versus future lawsuit, tax breaks versus steep government fines, or legal protection versus legal liability.
You will need to use an Independent Contractor Agreement whenever you or your company hires a person or business to complete a specific task with defined start and finish dates. A traditional Employment Contract should be used when you are hiring or hired permanently, and a relationship of control and supervision exists.
The Department of Labor has laid out a 6 prong test to determine whether or not someone is an employee or independent contractor. When determining whether an employee-employer relationship or an independent contractor relationship exists, a court will look at:
- Whether the work performed was integral to the business
- Whether the worker exercises any managerial skills
- Who owns the tools, equipment, and work-space
- Whether the worker’s skill incorporates independent business judgment and the level thereof
- The permanency of the working relationship
- The degree of control by the employer
Four Differences You Should Know
Financially, employees enjoy greater benefits than an independent contractor, in what is known as “the hidden paycheck.” “The hidden paycheck” includes health insurance, disability, and retirement benefits, while an Independent contractor enjoys no such perks and pays for their own health insurance, is responsible for their own injuries on the job, and has no portion of their paycheck set aside for retirement.
Aside from general commuting costs and business clothes, employees forego having to fork out for start-up costs, staffing, and office expenses, and other various professional costs.
In the realm of tax implications, employees and independent contractors are treated very differently. Companies are required to pay certain taxes on behalf of their employees, including federal and state employment tax, while independent contractors are solely responsible for their own “self-employment tax.”
As an independent contractor’s income increases, so do their employment tax burden. The misnomer of an independent contractor or employee can carry harsh punishments and repercussions by the Department of Labor, resulting in exorbitant fines, unemployment claims, or even federal lawsuits. If you still are unsure about the classification of your employee, leave it up to the IRS, and fill out a Form SS-8.
Employees benefit from greater security in their job and are often protected by state and federal law dictating procedure for overtime and discrimination issues. Independent contractors benefit from no such protection, and also are restricted from joining unions, ultimately leading to less negotiating power.
Employers however are subject to stricter liability for the acts of their employees (i.e. negligence), while there is no liability for the negligence of independent contractors. For example, if you own a company specializing in painting, and one of your employees drops a paint can off a ladder injuring a bystander, you are held liable for the damages.
However, if the painter was hired as an independent contractor, and little to no control was exercised over them, the liability would fall upon the independent contractor.
If you’re an artist, writer, or professional with an original work of authorship and want to protect your proprietary rights in it, understanding the difference between being an independent contractor and employee could be the difference between financial success and ruin.
As an employee, you will likely have to assign any and all intellectual property rights in your work created during employment to your employer, while as an independent contractor, you retain your proprietary rights in the work. So, what exactly does it mean to “retain rights” in a work?
A copyright grants the owner the right to reproduce the work and make copies, distribute or sell it, create derivative works, and any performance or display rights to realize a commercial gain. If you are an independent contractor, know that by default, the copyright in the original work is yours, unless you have clearly entered into a written agreement that the work is a “work for hire.”
When classifying employees as a traditional employee or independent contractor, reactivity is going to land your company in hot water. Proactivity towards classification will help prevent and save you or your business from a barrage of financial, legal, and personal troubles while taking advantage of certain benefits.
Make sure you understand the above 4 differences between an employee and an independent contractor before you enter into your next contractual agreement.