Independent Contractor or Employee?
As we encounter the end of one year and the beginning of another, many year-end accounting tasks are upon us, including the issuance of W2s and 1099s to those who have performed work for us during 2021. To determine who needs to get which type of tax form, we must be able to properly classify these workers at the onset of their service.
What is the difference between employees and independent contractors? It’s a hot topic that can cause a lot of confusion, but it’s important to understand. In this tip, we’ll help you learn how to spot the differences and classify these different types of workers properly. Also addressed is why it’s important to know the difference in these types of workers, the definitions of an independent contractor and common characteristics of this title, and the implications for paying these workers.
Year End Forms
What is a W2 Tax Form?
A W2 is the form that an employer must send to an employee and the IRS at the end of the year. The W2 form reports an employee’s annual wages and the amount of taxes withheld from his or her paycheck. Simply put, this form is meant for regular employees in the traditional sense who receive regular salaries.
These individuals work directly for your business and are in no way self-employed, independent contractors or freelancers. In many cases, they receive benefits like health insurance, retirement plans (TRS), life insurance, etc. They also pay less in Social Security and Medicare taxes because their employers typically contribute half. With a W2, an employee’s taxes are automatically deducted from their paycheck, and this money is sent to the government.
What is a 1099 Tax Form?
A 1099-Misc is defined as a tax form that reports the year-end summary of all non-employee compensation. This form covers rent, attorney fees, self-employment and independent contractor income, and several other kinds of miscellaneous income. This is meant for workers who aren’t employees in the traditional sense and don’t receive a regular salary.
These individuals are usually classified as independent contractors or freelancers and don’t typically receive benefits. They must also pay the full amount Social Security and Medicare taxes, as well as self-employment tax, directly to the IRS on their own behalf. That is because, unlike traditional employees with W2s, they get their full pay without any automatic deductions. They are personally responsible for keeping track of their taxes and submitting them to the government. If an independent contractor earns $600 or more throughout the year, they must receive a 1099 from your charter.
Why it’s important
It impacts many factors:
- Taxes and withholdings, with payment timing and responsibilities
- Eligibility status for certain programs and benefits contributions
- Responsibility: liability and insurability
- Separation from employment implications (unemployment, reasons to term)
- Workers’ compensation premium rates
What is an Independent contractor?
The information following was nicely summarized by Texas Mutual, a workers’ compensation insurance provider. To understand the difference between an independent contractor and an employee, we need to unpack the independent contractor definitions, which are determined by the Texas Labor Code.
- According to TLC 406.141, “independent contractor” means a person who contracts to perform work or provides a service for the benefit of another and who:
- Is paid by the job and not by the hour or some other time-measured basis
- Is free to hire as many helpers as desired and may determine the pay of each helper, and
- Is free to, while under contract to the hiring contractor, work for other contractors or is free to send helpers to work for other contractors.
According to TLC 406.121, “independent contractor” is a person who contracts to perform work or provide a service for the benefit of another or who ordinarily:
- Acts as the employer of any employee of the contractor by paying wages, directing activities, and performing other similar functions characteristic of an employer-employee relationship
- Is free to determine the manner in which the work or service is performed, including the hours of labor or method of payment to any employee
- Is required to furnish or to have employees, if any, furnish necessary tools, supplies, or materials to perform the work or service, and
- Possesses the skills required for the specific work or service.
Common characteristics of independent contractors
The Texas Workforce Commission (TWC) offers an Independent Contractor Test to help determine if someone is an employee or independent contractor. As we help Texas charters properly identify their workers, Charter School Success uses this test as just one part of our evaluation to help interpret the Texas Labor Code provisions.
Below you’ll find a quick reference of the common characteristics of independent contractors from the TWC test to help you recognize the differences. It’s important to note that no single factor makes the determination, and not every situation will involve each factor.
Typically, an independent contractor:
- Does not receive instructions
- Uses his or her own methods and does not need to receive training
- Has significant investment in their independent business
- Does not always personally complete services
- Has control of their own assistants
- Is hired for a specific job and there is no continuous relationship
- Sets own hours of work
- Does not receive progress reports
- Receives payment per job
- Supplies their own tools
- Can realize profit or loss
- Works for multiple companies
- Is not exclusive to one firm
- Has the right to choose location (typically)
- Sets their own sequence of work
- Can advertise their business as available to the public
- Cannot be terminated at will if they meet their contract
- Is liable for non-completion or breach of contract
Alternatively, employees are more likely to receive instructions on when, where, and how to perform the job. Employees are often trained by a more experienced person or are required to attend meetings and take training courses. Unlike an independent contractor, they do not have an investment in the business. An employee is dependent on the employer for the work. They are often subject to non-competition rules and can be let go at-will.
Questions to ask
Here are some important questions you should ask to help you come to a determination:
- How is/are the independent contractor(s) paid? Are they paid by the job, hour, or by contract?
- Is the independent contractor able to hire others to perform work? If yes, who pays the others hired?
- Does the independent contractor work for anyone else?
- Does the independent contractor have their own employees?
- Who determines how the work is performed?
- Who provides the tools, supplies, or materials?
- What skills does the independent contractor possess?