Contractors vs Employees and Why It’s Important

You’ve decided you need help with your business and its time to pay someone to do so.  All of a sudden you are inundated with terms like independent contractors, employees, FICA, Medicare, SUTA, 1099 and the dreaded T word, taxes. Interestingly it’s the one conversation that I’ve had with nearly every single client I’ve ever worked with. Knowing how critical this information is, I’m going to help decipher it and take away some of the frustration and fear that comes with finding help for your business.

Let’s tackle the two key terms relative to who is performing the service for your business.

Independent Contractors are considered to be exactly as described, independent. They are responsible for paying their own taxes. As the person hiring them you only need to report what you’ve paid them to the IRS at the end of the year and even then, only if you pay them in excess of $600 that year. A good example would be hiring Avery to be a second shooter for you. Julie is a photographer herself and owns her own business.

Employees are not independent. They are hired to work for and become a part of your business. As such you have to withhold taxes from their checks, you are responsible for paying additional taxes to the IRS based on their payroll and the reporting requirements are more extensive. Not to mention the fact that outside of payroll you have to worry about things like human resources, health insurance, paid time off, etc… An example would be hiring Samantha as your personal assistant. She comes in three days a week and gets paid an hourly rate. When she comes to work you direct her on what she’s supposed to be working on and you control what she does.

Contractors vs employees for creatives | Rising Tide Society
Photo by Lauren Carnes

The natural inclination of nearly every small business is to treat everyone like and independent contractor because it is so much easier to handle. Unfortunately, that doesn’t work out so well for the IRS, state governments, and any number of other agencies/businesses that are dependent on or who regulate employees. As a result, the IRS has created a set of guidelines to determine if you’re hiring an independent contractor or employee.

The IRS uses three common law rules to determine if the person performing the business is an employee or independent contractor. They are as follows:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

– YES – Employee
– NO – Independent Contractor

2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

– YES – Employee
– NO – Independent Contractor

3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

– YES – Employee
– NO – Independent Contractor

When asking yourself these three questions, if you’re lucky enough to get a clear cut answer you’re in good shape. Sometimes it’s just not that clear. In those situations, the IRS advises you to look at the engagement as a whole and determine which best applies. If you’re still stumped, then you can get a ruling from the IRS directly on whether this person is an independent contractor or employee.

In the long run, you need to ensure that you are classifying your new hire correctly so you are meeting your tax and other financial obligations to state and local governments.  If not, it could mean a lot more hassle and payments in the future.