In the online business world, you hear a lot about independent contractors. Sometimes they're referred to as consultants, contractors, freelancers, or 1099ers. In fact, as an online business owner, you may be providing services for other entities or individuals as an independent contractor.
It's important to know the difference between an independent contractor and employee because misclassification of someone who works for you can cause issues with the IRS.
Sounds like great fun, right?
Please keep in mind that the information provided here is general. State laws vary and your state may have different criteria. Make sure you check before determining the appropriate classification.
Independent Contractor or Employee: A Guide for Online Business Owners
What is an independent contractor?
An independent contractor is a person or business who provides services to another entity. The terms are typically agreed to in a contract. An independent contractor is self-employed and is paid as a freelancer, which means that the contractor is required to pay all taxes associated with its position.
Examples of independent contractors that you will encounter as an online business owner are: virtual assistants, graphic designers, social media managers, content contributors, freelance writers, or coaches.
What is an employee?
An employee, on the other hand, is hired to provide services on a regular basis, in exchange for compensation. The employer is required to pay taxes for its employee, unlike an independent contractor.
How does an independent contractor differ from an employee?
Many companies prefer using independent contractors because it allows greater flexibility and can help them save in labor costs. However, not every role can be filled by a contractor, pursuant to the IRS, the Department of Labor, and many state agencies.
The IRS considers three main areas when determining if someone should be classified as an employee or independent contractor.
Who controls how and when the job is done?
An independent contractor typically:
- is in charge of his or her own hours;
- work with multiple clients (unless the parties agr
- receives a net salary with deductions taken for applicable tax
- ee to some exclusivity in their contract);
- works outside of the company's offices; and,
- completes projects with minimal supervision from the company.
An employee typically:
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- is under direct supervision from the company;
- works specific hours; and,
- does not control how or when the job is done.
Who controls how the work is compensated?
An independent contractor typically:
- directly pays all applicable taxes;
- is paid the amount agreed to by the parties in full, with no deductions; and,
- is typically responsible for the cost of doing business, such as supplies or equipment.
An employee typically:
- taxes are paid through the employer, such as Social Security, income tax, etc.;
- may be reimbursed for certain business expenses related to doing their job; and,
- uses supplies and equipment provided by the company.
What kind of relationship have the parties agreed to?
An independent contractor typically:
- enters into a written agreement with the company that states an independent contractor relationship is being formed;
- does not receive benefits typically associated with employment, such as vacation or a pension plan; and,
- does not perform a key piece of the company's business.
An employee typically:
- is hired specifically as an employee and submits the applicable IRS paperwork to the hiring company;
- will receive benefits typically associated with employment, such as vacation or a pension plan, and;
- performs or contributes to a key piece of the company's business.
Don't misclassify!
If you are ever unsure of how to classify a new hire, you can submit an SS-8 to the IRS. It takes about 6 months to receive a response, but this will give you a definitive answer.
