What’s the difference between an employee and an independent contractor?

Employees get paid a regular wage, receive employee benefits, have taxes withheld from those wages, and they have their work and schedule dictated by the employer. Full-time employees are also offered more protection: severance, workers compensation, anti-discrimination protection, etc. Their employees have to pay payroll taxes on their wages. There’s also a lot more paperwork and forms for new hires.

Independent contractors are the reverse. They tend to get paid for projects, they worry about their own taxes, and work when and where they want. For tax purposes, the IRS considers them to be self-employed, which means they have to pay self-employment tax.

The main difference boils down to the degree of control: if the employer is dictating all the terms and doing so consistently over time, the person is probably an employee. Contractors are usually classified as self-employed individuals or individuals who are employed through another entity, such as an outside vendor, which means they are responsible for paying their own taxes. Unlike employees, who you split the tax burden with, when you pay a contractor you do not pay any payroll taxes.

Sweet! So why would I ever hire an employee? Because, in the eyes of the IRS (and also in the eyes of state courts!), employees and contractors are not interchangeable. Each has its own legal classification, and if you hire someone as a contractor who should be an employee, you can get penalized and be subjected to retroactive payroll taxes and other costs. In other words, you will get in trouble and pay the government (and maybe even the individual employee in question) lots of money.There are significant penalties for misclassifying employees as independent contractors. Make sure you know how to tell the difference between an independent contractor and an employee before you submit a 1099.

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