Contractor vs Employee: How to Determine What Your Team Members Are
So your business is growing and you need to hire… exciting, right?! Overwhelming too, right? As a new and/or growing business owner, it can be difficult to determine if a team member is truly a contractor or an employee. Furthermore, misclassifying an employee as a contractor can be costly. Let’s talk about how you can tell the difference between the two. I’ll give you a hint though…. In the words of THE Janet Jackson, it’s “CONTROL”.
What is an Independent Contractor?
An independent contractor is a self-employed person or entity contracted to perform work for—or provide services to—another entity as a non-employee. Hiring an independent contractor can be quite beneficial from a financial standpoint, but that financial benefit isn’t what determines if this person (or entity) is actually a contractor.
When someone operates as an Independent Contractor,
You don't pay employer payroll taxes or withhold any taxes (unless they’re subject to backup withholding). They are responsible for calculating their income, expenses and paying their own payroll and income taxes.
You don't have to offer them the same benefits that you offer your employees (although you could if you chose to).
You're not subject to most federal and state labor laws requiring minimum wage or overtime.
They generally carry their own liability insurance policy, and if they have employees, they may also have workers compensation insurance.
They typically use their own equipment, work on their own schedule and establish their own rates… they maintain majority control of how they work, when they’ll work and/or their pay rate.
What is an Employee?
Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it’ll be done. Employees get paid a regular wage, receive employee benefits (if offered and if they are eligible), have taxes withheld from their wages, are covered by the employer’s workers compensation insurance if the state requires them to have it, and they have their work and schedule dictated by the employer.
Before you make any new hires or change the work status of any current employees, it’s important to know that employees are protected by many labor laws in New Jersey, including the Unemployment Compensation Law. Independent contractors do not receive such protection. That is why it's so important to make sure workers are properly classified.
How Do You Know What to Classify Your Workers As?
There’s a few different ways to determine if your current/future team members are independent contractors or employees. You are required to comply with both Federal (IRS) and state rules since your state may have more specific rules than the IRS. I’ll share the Federal (IRS) and NJ tests below.
The IRS uses 3 categories to determine how to properly classify a worker.
The first category is examining your Behavioral Control (are you seeing a theme here?!)
If you train the worker, direct their tasks with detailed instructions, set specific hours, and dictate how the work should be completed, the IRS is more likely to classify them as an employee.
On the other hand, if the worker sets their own hours and decides how and when to get the job done, that could mean they’re an independent contractor.
EXAMPLE: Consider how you work with your accountant. You don’t tell your accountant how to prepare your tax return, the time and day you want it prepared or the rate you’re willing to pay. Instead your accountant prepares your tax return using their equipment, according to their schedule and gives you the fee for preparation. Your accountant is a contractor.
The second category is Financial Control (can the business control the financial and business aspects of the worker’s job?)
Independent contractors are more likely to incur unreimbursed expenses than employees.