Being a Contract Employee?

The title “contract employee” is essentially a contradiction in terms. Technically, a worker can be a contractor or an employee, not both. The Internal Revenue Service spells out the differences between a contract worker and an employee, and employers should be aware of these differences to avoid misclassifying those who work for them.

Employees

Someone who supplies services is an employee if the employer controls what is done and how it is done. Even if the employer does not directly control the work, he has the right to do so when his workers are employees. An employer must withhold income taxes, Social Security and Medicare taxes, and must pay unemployment insurance tax for employees. For tax purposes, workers receive W-2 forms.

Independent Contractors

Independent contractors generally have more than one client. They can often choose to be paid in hourly or flat-rate terms and submit invoices for completed work. They are responsible for paying their own income taxes and receive 1099 forms for tax purposes. Companies generally do not have to pay unemployment tax on payments made to independent contractors, nor do they have to withhold income taxes or Social Security and Medicare taxes.

Common Law Rules

Three IRS categories -- behavioral, financial and type of relationship -- outline the factors that distinguish contractors from employees according to the amount of control exerted by the employer and the independence enjoyed by the contractor.

Behavioral Control

Behavioral control describes whether the employer has the right to control or direct how the worker performs the job. Control includes the types of instructions and degree of instructions given as well as training and evaluation systems in place. An employee can expect instructions about when and where to work; the tools and equipment to use; whether to hire workers to assist; where to purchase supplies; and the order in which the work is performed. The more detailed the instructions given to the worker, the more control is exercised and the more likely that the worker is an employee, not an independent contractor. If the worker receives training for performing the job, the company wants the work performed in a certain way by employees, while independent contractors generally use their own methods of performing tasks. Evaluation of a worker’s performance could apply either to a contractor or an employee.

Financial Control

Financial control is another determining factor distinguishing an independent contractor from an employee. An independent contractor generally invests in his own tools and equipment and has unreimbursed business expenses. The independent contractor can also experience profit or loss from his business, unlike employees who receive regular pay on hourly or weekly schedules. Contractors can advertise and are available to work anywhere.

Type of Relationship

A worker can have a contract stating he is an employee, but that alone does not define the worker’s status. A company pays benefits such as insurance, pensions, vacations and sick days to employees, while independent contractors generally do not receive such benefits. When a worker is hired for an indefinite period, he is generally an employee. A worker who provides essential services may be considered an employee, despite his status outside the company.

Misclassification

Companies may find it advantageous to use independent contractors, rather than employees, because of hiring flexibility and savings in benefits. However, misclassifying workers can be costly. An employer can be forced to reimburse wages and pay retroactive taxes and penalties for workers who were classified as employees when they were actually contractors.