Businesses in need of professional services constantly debate the whether it is more appropriate to hire an employee or an independent contractor. This article examples the characteristics of an employee and an independent contractor. In doing so, we examine the costs associated with each.
Characteristics of an Employee
An employee is an individual who works within a business providing services to a business in exchange for compensation. The phrase “works within” is the primary differentiating factor between an employee and an independent contractor. An employee is characteristically under the close control of the employer. That is, the employer controls the nature, process, and timing of the work the employee undertakes for the company. Even if an employee has a great deal of autonomy in how she does the work and the time, if the employer maintains the ability to control the specific activities and timing of the employee, then she is an employees.
Characteristics of an Independent Contractor
An independent contractor is not a member of the employer’s business. She, in effect, has her own business and is selling her personal or business services to the employer. As such, the employer requests the services of the contractors, but does not exercise complete control over the timing and manner of the work performed.
Why Does This Matter?
It is important to remember that, whether an individual is an employee or independent contractor is not determined by the characterization that the employer ascribes. It is based upon the above factors. Most employers would prefer to designate employees as independent contractors. This would save the employer from having to withhold payroll taxes from the employee’s compensation and from including the employee in company benefit plans. Many small businesses routinely mischaracterize part-time employees as independent contractors. The effect is that the individual pays self-employment taxes, which are higher than just her portion of payroll taxes, and is not entitled to benefits such as worker’s compensation and unemployment through the employer.
True Cost of an Employee
The costs associated with the employee will vary depending upon the benefits the employee receives.
Wages – As described above, the cost of an independent contractor is made up solely of the price she charges for her services. Because of the lack of benefits associated with working as an independent contractor, an employer should expect to pay a higher rate of compensation the contractor per hour worked.
FICA Taxes – With regard to FICA taxes, an employer is required to pay 6.2% and the employee is required to pay 6.2% of wages up to $128,400. Each also pays 1.45% of wages with no cap on the wage amount.
Unemployment Insurance Rate – Unemployment insurance protects the employee from the repercussions of losing employments without another source of income. It only applies when the employee loses her job through no fault of her own. Unemployment insurance is a combined federal (FUTA) and state program (SUTA). The taxable wage base is $7,000 at the federal level and is usually similar at the state level. The federal tax rate is 6%. So, the federal amount on $7,000 would be $420 per year. The federal government provides a credit of 5.4% for those timely filing state state unemployment insurance (regardless of what the state rate of tax is). It effectively moves the federal rate down to $42 per year. The state rate will vary by state and may be subject to a credit for the federal amount paid.
Worker’s Compensation – This provides benefits to an employee who is injured on the job and cannot earn her wages. This insurance pays a percentage of her salary during the temporary injury. The employer in most states must purchase the insurance (either privately or through the state) if they have above the minimum number of employees (0-5 in most states). The amount for the insurance is based upon the employee’s wage and the type of industry (NCCI codes). The rate varies between .4 – 3% of wages.
Other Benefits – Most employers pay for or share the expense of a number of employee benefits. These benefits can cost in the thousands of dollars per employee.
LawTrades Understands Employment Law
When making the determination of whether to hire an employee or independent contractor, it is important to understand the difference between the two types of workers. Designating an employee as an independent contractor is not determinative. Administrative agencies governing the benefits to which an employee is entitled or an employer is obligated can challenge the employee’s designation. This could result in fines or other penalties for the employer.
Before hiring an employee or independent contractors, it is helpful to discuss the job characteristics with an expert. The employment attorneys at LawTrades can provide you with the information you need to comply with all applicable regulations.