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13 Mar 2016
Which Is Better: Employee Or Independent Contractor?

A pal recently picked up and moved her life across the country to take work with a start-up company. Although move was risky, the ability was too amazing to feed up.

Cliff Davis Tampa FL



Initially she was hired as being a full-time employee, but eight months later, the business changed her role to that particular of an independent contractor. To me, this raised two questions: Could it be better for a worker to get as an independent contractor or perhaps a regular employee? And why might a manager choose one over the other?

Within the last 40 years, Congress has gone by several laws that outline the distinctions between employees and independent contractors with their compensation, benefits and relationships on their employers. Section 530 in the Revenue Act of 1978 laid the initial groundwork for the regulations we follow today.

Within the 1960s and early 1970s, there is a growing concern for the future of the Social Security program. Some blamed the funding issue on independent contractors skimping on self-employment tax. This belief led to an increase in audits with the Internal Revenue Service. This, subsequently, led to criticism that this IRS was too aggressive in classifying workers as employees, rather than as self-employed independent contractors, and that it applied its criteria inconsistently. Congress responded by enacting Section 530, providing safe harbor for employers by preventing the IRS from retroactively reclassifying independent contractors as employees. Section 530 protected employers from large penalties and back taxes after they met the law's standards.

For employers to be eligible for a safe harbor under Section 530, the IRS required: a reasonable cause for treating the workers as independent contractors; consistency in how such workers were treated; and proper tax reporting using 1099 forms for those categorized as contractors. Though Section 530 was initially intended to be an interim measure for that audit issue of the '60s and '70s, it took over as the enduring baseline for today's worker classification regulations. Subsequent legislation, including the Small Business Job Protection Act of 1996, further clarified the text in Section 530, as well as the rules of safe harbor availability and the question of who props up burden of proof for classifications.

Many employers use the following rule of thumb to tell apart between a contractor as well as an employee: If an employer has the right to control the two means by which the worker performs his / her services and the ends that really work produces, the worker is considered an employee. In 1987, the internal revenue service released a 20-factor list, depending on prior cases and rulings, to help employers resolve many of the "gray areas" that this rule won't resolve. Some of the factors included listed were: training; set hours of work; payment by the hour, week or month; furnishing tools or materials; doing work on the employer's premises; and payment of economic expenses.

For example, when the employer requires the worker to undergo a training class before starting work, or to use particular tools or materials the business provides, the worker would qualify as an employee. Similarly, when the employer requests the worker be on site with the company headquarters from 8 a.m. to five p.m. every day, the worker is an employee, not an independent contractor.

The overarching theme of all these factors is that a company has the right to control how a staff produces his or her work. When hiring an independent contractor, the business gives up this control. Independent contractors have a very strong focus on the outcome, not the process to perform the project. Overall, the IRS' 20-factor list helped many employers develop a baseline to evaluate the role of their hires and steer clear of misclassification.

In 1996, the government took the list a stride further by identifying three broad kinds of evidence to be used in discriminating between a worker and an independent contractor. The 3 categories are behavioral control, financial control and relationship from the parties. In general, employers could only minimally regulate contractors' behavior. Contractors have the freedom to subcontract the work they receive, complete the job in the way they feel is most effective, and set their own hours and work location.

Financial control ensures that contractors' payment standard will depend on a "per task" or "piece work" pay. Therefore, how long and energy contractors expend for the work they produce is about the contractors, not their employers. In contrast, employees are typically paid a per hour wage or a salary, which their employers monitor and control, combined with the number of hours worked. Employees also may receive additional benefits, such as health coverage or retirement plans, which independent contractors don't receive.

The third category, relationship of the parties, refers to the increasing practice of employers requiring employees to sign non-compete clauses or non-disclosure agreements. Generally, independent contractors aren't required to sign such legal contracts. Contractors can work with multiple employers when they so choose - even competing employers. A manager does not have the right to control the relationships an impartial contractor may develop away from their work for that particular employer.

The legal distinction between employees and contractors is see-through. Why, then, would a worker or an employer prefer one situation within the other? There is no wrong or right answer when it comes to a specialist or employee role, merely preferences per situation.

An independent contractor enjoys more flexibility when compared to a full-time employee. The contractor can essentially be his own boss, by developing his very own schedule, working without close supervision, and signing up for as heavy or light a workload as they sees fit. This provides open-ended earnings potential. Employed by multiple employers also gives contractors more the rate of employment in one sense, because one employer going broke or cutting back on staff won't destroy the contractor's whole stream of revenue. For an employee, however, it may be more appealing to possess a predictable schedule, the possibility for advancement, as well as a more stable income flow.

From an employer's perspective, an impartial contractor may be a good fit when the employer does not have the time or manpower to spend, monitor or use an employee full time. The employer may simply need anyone to complete projects with an occasional basis. In contrast, if an employer would rather maintain close supervision and requires a worker who is positioned on a regular and predictable basis, and if the employer has the methods to pay the worker a stable salary or hourly wage, then hiring the worker as an employee will be a more logical decision.

Employers and workers should also weigh factors like taxes, health care and retirement benefits to their decisions. When employing an independent contractor, the employer does not pay the worker's taxes; rather, independent contractors are accountable for paying the tax themselves through the self-employment tax on Schedule SE, which covers their Medicare and Social Security tax. A manager withholds the equivalent tax from an employee's paycheck. Contractors can deduct the employer-equivalent area of the self-employment tax when calculating their adjusted revenues. However, this deduction only affects taxation, not self-employment tax. All self-employment earnings are then reported on Schedule C.

Generally, employers are accountable for providing a 1099 form to contractors because of their income reporting on Schedule C, in particular for income amounts over $600. However, the load falls on the contractor to maintain accurate records, regardless of whether they received the tax forms or proper documentation. Independent contractors also needs to be conscious of making estimated tax payments all through the year, which can be a challenge when earnings are not as steady being an employee's would be. When they purchase equipment or materials, or utilize a home office for work, independent contractors must track their expenses so that they can be deducted properly.

Independent contractors deduct their business expenses directly against their business receipts, reporting the knowledge on Schedule C of Form 1040. Employees sometimes incur unreimbursed business expenses too, for example for tools or union dues. Employees get less favorable treatment, handling such expenses as miscellaneous itemized deductions on Schedule A. Most such expenses are deductible only if they exceed 2 percent in the employee's adjusted gross income. Overall, independent contractors face a more complex tax situation, even if it is sometimes more favorable.

The current passage of the Affordable Care Act raised concern and uncertainty regarding which insurance and care programs will likely be available to independent contractors as well as to those seeking individual coverage. Organic beef see a change, too, of what options employers will provide for their employees down the road, particularly within company-sponsored group plans. The complication and uncertainty of the new health care landscape will take some time to play out, for independent contractors and employees alike.

Additionally, workers should consider the impact of operating just as one independent contractor or as an employee on their retirement planning. Many employers provide use of 401(k) plans or profit sharing plans, which assist employees in preserving for their retirement (in addition to individual saving they will often pursue via IRA or Roth IRA accounts). Independent contractors will likely need to save for their retirement positioned on their own. Though certainly manageable, this arrangement places greater responsibility on independent contractors to ensure not only that they save enough, but in addition that they follow regulations to be contributing properly. Otherwise, they could end up paying penalties for overcontributing or causing the wrong type of account, based on their income levels.

Taking into consideration the pros and cons of each kind of work, I come back to my original question. Is it better for my friend to start as an independent contractor instead of an employee? Maybe. The modification offered her flexible working hours, less supervision along with the opportunity to contract with other companies, with the resulting potential for additional income. In exchange, she lost a stable salary, as well as her health and retirement benefits. The only person who can say if your trade was worthwhile is my good friend. As for why the start-up company preferred her as a contractor, I can only speculate. My instincts repeat the primary factor was probably cost. By cutting health insurance and retirement benefits and paying her piecemeal, they'll likely save money, enabling them to put more funds into the young firm.

Cliff Davis Tampa FL



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