The Ultimate Independent Contractor vs Employee Checklist: How to Determine the Difference

There are many benefits to being an independent contractor, such as setting your own hours and working from home. However, it is important to understand the key differences between independent contractors and employees before you make the decision to become one or hire one. The Ultimate Independent Contractor vs Employee Checklist will help you with that.

In this blog post, we will discuss the differences between an employee and an independent contractor in terms of payroll, taxes, and more. Do you classify as an independent contractor? We will tell you right here!

Nowadays, whether a worker is legally classified as an “employee” or an “independent contractor” determines whether or not he or she is entitled to any labor-law or employment-law rights. This includes the right to a minimum wage, healthcare insurance, overtime compensation, unemployment and employment benefits, as well as workers’ compensation.

That sounds clear enough, right? May be on paper, but sometimes, in reality, misclassifications occur and affect the people doing the work.

So let’s dive into the topic!

Why Is It So Important To Distinguish Between Employee and Independent Contractor?

As we stated before, the first thing you should know is that an independent contractor is not entitled to the same labor and employment protections as employees. This means that if an independent contractor is injured on the job, he or she is not entitled to workers’ compensation benefits.

Independent contractors also do not have the right to minimum wage, health insurance, overtime pay, unemployment, or other employee welfare. In addition, independent contractors are responsible for paying self-employment tax (including Social Security and Medicare tariffs).

Because of this lack of protection and benefit, some employers try to mask an employee as an independent contractor in order to avoid paying these costs. However, there are severe penalties for doing so, including fines and back pay owed to the employees.

This is why it is so critical to define the limits of an independent contractor!

Payroll Tax 

One of the most significant differences between independent contractors and employees is how they are taxed. When you are an employee, your employer withholds taxes from your paycheck. These tariffs include Social Security and Health Insurance, as well as federal and state income tax. 

Payroll Taxes Includes:

  • Social Security and Medicare
  • Federal and State Income Tax

An independent contractor, on the other hand, is responsible for paying their own taxes. They do not have any taxes withheld from their paychecks. Instead, they are expected to set aside funds throughout the year to pay those.. 

Basic Definitions

Employee

An employee is someone who works for a company in exchange for wages and other benefits. Employees are protected by labor laws, and they are expected to work according to the company’s rules and regulations. 

Independent Contractor

By definition, an independent contractor, also known as an IC, is an individual who provides services to the general public under a contract. However, independent contractors are not an employees of the company they are contracting with, therefore, they are not subject to the same rules and regulations of federal employee law. 

According to the US Department of Labor, these contractors are usually classified as self-employed individuals who control their work schedule, and business processes, earning a commission for each job they complete.

While an independent contractor has many advantages, such as the ability to set their own hours and rates or their own business processes, they also carry more risk than traditional employees. Especially, since they are exempt from the FLSA.

Fair Labor Standards Act

While hiring independent contractors can save the business money on payroll, taxes and benefits. It is important to make sure that the employees you hire classify as IC and actually meet the legal criteria as such. 

The Fair Labor Standards Act (FLSA) is a federal law that establishes minimum wage, overtime pay, recordkeeping, and child labor standards affecting full-time and part-time workers in the private sector and Federal, State, and local governments. 

Independent contractors are not subject to the FLSA as they don’t fall into federal employee law .

In summary, contractors:

  • are not subject to the FLSA’s minimum wage or overtime provisions. 
  • are not entitled to the other protections provided by the FLSA, such as the right to receive holiday or vacation pay, or be fired only for cause. 
  • are not protected by anti-discrimination laws, such as those prohibiting discrimination based on race, color, religion, sex, national origin, age, or disability. 
  • are not entitled to unemployment insurance or workers’ compensation if they are injured on the job. 

How to Determine If You Are an Independent Contractor? 

One of the tools used to determine whether a person is an employee or an independent contractor is the IRS 20-point test. 

The test looks at various factors, including the degree of control the employer has over the employee, the type of work being done, and the relationship between the parties. 

If the person meets all the below 20 points, they are classified as an independent contractor. However, if they fail to meet even one point, they are classified as an employee.

The IRS 20-point test is important because it can have a significant impact on a person’s taxes and eligibility for certain benefits. 

In general, workers who score high on the test are more likely to be classified as an IC, while those who score lower are more likely to be classified as employees.  

The IRS 20 point test can be a valuable tool in understanding the complex issue of employee classification.

For example, let’s take a look at the first 5 points:

Instructions

The first part of the test looks at how much control the company has over the person. If the business has a great deal of control over what the person does and how he/she does it, then theperson is more likely to be classified as an employee.

Training 

If the person is required to undergo extensive training in order to do their job, this is an indication that they are more likely to be classified as an employee. 

Integration

If the person is integral to the company’s business and their work cannot be easily replaced, this is an indication that they are more likely to be classified as an employee. 

Services rendered personally

This is one of the most important factors in the test. If the person is required to render their services personally, this is a strong indication that they are an employee. 

Hiring, supervising, and paying assistants

If the company has the power to hire, supervise and pay assistants, this is an indication that they have a great deal of control over the person and that the worker is more likely to be classified as an employee.

Keep in mind that this is just a brief overview of the IRS 20-point test. For more information on how to determine whether you are an independent contractor or an employee, please consult with a qualified tax professional. 

What Are The Key Differences Between Employees and Independent Contractors?

The main difference between employees and ICs is that employees are under the control of their employer, while ICs are in business for themselves. 

  • Work Schedule: ICs typically have more control over their work schedule than employees. Employees are typically required to work set hours, while ICs can often set their own schedules. 
  • Location of Work: ICs often work from home or another location of their choosing, while employees are typically required to work at the employer’s place of business.
  • Payment: ICs are typically paid by the task or project, while employees are typically paid by the hour or week. 
  • Welfare: ICs are not typically eligible for benefits, such as health insurance and retirement plans, while employees often are. 
  • Taxes: ICs are responsible for paying their own taxes, while employees have taxes withheld by their employer.

Misconceptions About Independent Contractors

Even though the Department of Labor (DOL) has been clear about the limitations of an independent contractor over the years, and in fact barely a year ago, this office announced a rule addressing the distinction between employees and independent contractors under the Fair Labor Standards Act (FLSA), there are still misconceptions around!

Exempt of Taxes

Sometimes it’s thought that an independent contractor is exempt from taxes, but that’s not the case. According to the IRS, ICs are accountable for paying their own Social Security and Medicare taxes, as well as any federal and state income taxes. 

They are also responsible for filing their own quarterly tax returns

While ICs do have to pay more in taxes than employees, they also have the ability to deduct certain business expenses from their tax returns. This can help offset some of the additional tax burdens they face. 

It’s important to note that an independent contractor is not subject to withholding by their clients, so it’s up to them to set aside money throughout the year to ensure they have enough funds available around tax  payment time.

Not Even One Employee Benefit

Another misconception is that ICs do not receive any employee benefits. While it is true that independent contractors are not entitled to vacation days or health insurance, they may be eligible for certain tax deductions and credits. 

Independent contractors can often save businesses money by eliminating the need for payroll taxes, employee benefits, and other employment-related expenses. Ultimately, this money can go to retirement savings. Great advantage! 

And speaking of which! 

Pros and Cons of Being an Independent Contractor

As with everything in life, being an independent contractor comes with ups and downs. 

Key Advantages 

  • Flexibility: You have a great deal of flexibility in terms of work conditions, work schedule, dates, and location.
  • You’re your own boss: You have the freedom to set your own schedule and work as much or as little as you want. 
  • You can be selective with your clients: ICs have the ability to be choosy about whom they work with. If you don’t like a client, you can simply stop working with them. 
  • You have the potential to have more earnings: Since independent contractors are paid by the project, they have the potential to make more money than employees who are paid by the hour.  There is no limit as to how much you can make as an independent contractor!

Key Disadvantages 

  • You’re responsible for your own taxes: As we mentioned earlier, ICs are in charge of paying their own taxes. This can be a significant burden if you’re not used to handling your own finances. 
  • Kept on a shorter leash: An independent contractor is often kept on a shorter leash than employees. This means that they can be let go at any time, without notice or severance pay. 
  • No guarantee of work: Since these contractors aren’t technically employees, they don’t enjoy the same job security as employees. There is no guarantee that you will always have work, which can be a scary proposition if you’re relying on this income to support yourself or your family. 
  • You have to be proactive about finding work: Unlike employees who have a guaranteed paycheck, ICs have to be constantly on the lookout for new clients and projects. 

Common Examples of An Independent Contractor

There are many different types of independent contractors, and it can sometimes be difficult to determine whether someone is an independent contractor or an employee. 

On-Demand Workers

The On-Demand economy has been growing rapidly in recent years, opening the door to a relatively new category of work, such as independent contractors. Companies like Uber, Lyft, and Handy are the main leverages of this type of service. On-demand workers are independent contractors who provide services to customers via an online platform or app. 

Freelancers

Freelancers are a good example of independent contractors. They typically work on a per-project basis, providing services such as writing, web design, or programming. While they may receive guidance from the contracting party, they are ultimately in charge of completing the work according to their own schedule and terms

Consultants

Consultants are professional experts who offer advice and assistance to businesses in a specific field. They are typically hired on a short-term basis to help with specific projects or tasks. While consultants are typically independent contractors, there are some exceptions. 

For instance, consultants who work for consulting firms may be considered employees of those firms. In general, however, consultants are considered ICs and are not subject to the same rules and regulations as employees.

Real Estate Agents

Real estate agents are usually hired by a broker to help clients buy, sell, or rent properties. They typically work on a commission basis, meaning they only get paid if they successfully complete a sale.

While real estate agents have some flexibility in their work schedule, they are also subject to certain rules and regulations set by their brokers. 

How Do You Pay Taxes As An Independent Contractor?

As an independent contractor, you are in charge of paying your own taxes. You will need to file a return with the IRS and make estimated payments throughout the year. 

When you file your return, you will need to include Schedule C, which is used to report your business income and expenses. You will also need to pay self-employment tax, which includes Social Security and Medicare. 

You can deduct certain expenses that are related to your work, such as office supplies and business travel.

The best way to stay on top of your tax obligations is to set aside money each month so that you have the funds available when you need them. By staying organized and staying on top of your payments, you can avoid any penalties or interest charges.

How Do You Fill Out A 1099-MISC Form For An Independent Contractor?

The 1099-MISC form is a document that is used to report miscellaneous income. This document is used by businesses to report payments made to contractors and other individuals for services rendered. The 1099-MISC form is also used to report royalties, rents, and other types of income. 

This record must be filed with the IRS by the business or individual who made the payment. The recipient of the payment must also receive a copy of the 1099-MISC form. 

withholding tax.

For example, if you are an independent contractor and you received $600 or more from a company during the year, the company will send you a 1099-MISC form.

Let’s say you have paid an independent contractor $600 or more during the course of a year; therefore you will need to fill out a 1099-MISC form and send it to the IRS. 

Here is tax checklist for you:

  1. Locate the correct form. You can find the 1099-MISC form on the IRS website.
  2. Fill out the payer information. This includes your name, address, and taxpayer identification number.
  3. Fill out the recipient information. This includes the independent contractor’s name, address, and taxpayer identification number.
  4. Enter the amount paid. This is the total amount of money that you paid during the year.
  5. The date the services were provided.
  6. Once the form is completed, you’ll need to send a copy to the contractor and file a copy with the IRS.

What Percentage of Taxes Do I Pay As an Independent Contractor?

The tax percentage that an independent contractor pays varies depending on several factors, including their tax bracket and the state in which they live. 

However, independent contractors are typically in charge of paying both federal and state tarxes, as well as self-employment tax. Self-employment tax is a tax imposed on self-employed individuals, and it covers Social Security and Medicare. 

You can use the IRS’s tax calculator to estimate the amount of taxes you’ll owe each year

The exact tax percentage that an independent contractor pays can vary, but it’s important to be aware of the additional taxes that may be owed. Independent contractors who are not aware of the tax implications of their work may end up owing a significant amount of money at tax payment time.

Best Practices For Working With An Independent Contractor

When hiring an independent contractor, be sure to:

  • Get everything in writing. This includes a detailed description of the work to be done, as well as the terms of payment.
  • Make sure the independent contractor has their own liability insurance.
  • Make sure to communicate frequently and provide feedback throughout the project. 
  • Do not withhold taxes from their pay.  
  • Finally, be prepared to pay a fair price for the contractor’s services. A good rule of thumb is to expect to pay about 10-20% more than you would for a full-time employee.

Working with an independent contractor can be a great way to get the work you need done without having to hire a full-time employee!

Checklist For Determining Whether You Are an Independent Contractor Or An Employee:

Now that we have discussed important facts about independent contractors, you can make an informed decision about which classification is right for you. Still not sure? Use our checklist below to help determine if you are an independent contractor or an employee:

  • Do you set your own hours?
  • Do you work from home?
  • Do you use your own equipment?
  • Are you paid for the project or task?
  • Do you invoice for your services?
  • Are you independent in your business decisions?

If you answered yes to most of these questions in this checklist, then you are likely an independent contractor. However, if you are unsure, it is always best to consult with an attorney or accountant to get expert advice.

Bottom Line

As the business landscape continues to evolve, independent contractors are playing an increasingly important role. In many industries, independent contractors are seen as a cost-effective and flexible solution to various workforce needs. As a result, there is a growing demand for independent contractors across a wide range of industries.

However, some challenges need to be addressed in order to ensure that this type of arrangement is successful in the future. One of the biggest challenges is ensuring that independent contractors are properly classified and treated as such, which ultimately guarantees the well-being and protection of all the parties involved.

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