Employees vs. Independent Contractors

Behavioral Control

Behavioral control determines if an employer has a right to direct how a worker does their assigned work. The existence of behavioral controls can indicate that the worker is an employee.

The IRS further defines behavioral control via four categories: type of instruction, degree of instruction, evaluation systems, and training.

• Type of Instruction
  Type of instruction identifies how an employer tells a worker or service provider to work. In most cases, only employees will be subject to these instructions. Independent contractors will likely set their own rules. Types of instructions can include: when to work, where to work, what equipment to use, where to buy supplies, what steps to take when working, and who to hire.
• Degree of Instruction
  Degree of instruction says that employers have more control over workers when instructions are more detailed. The more detailed the instructions, the more likely the worker is an employee. But, some jobs require little instruction. So the main question here is whether the employer has the power to instruct in detail.
• Evaluation System
  An evaluation system provides methodology for determining the quality of work performed. Evaluation systems for both employees and independent contractors often assess the work’s end result. For employees, however, there is usually the added evaluation of how the work was performed throughout the process.
• Training
  Training occurs when a business provides lessons about how to do a particular job. For example, an employee hired to do technical writing will already be a proficient writer, but the employer will provide training about how to write for their specific business. Training is usually reserved for employees. Independent contractors are hired because they already know how to accomplish the tasks at hand.

Financial Control

An employer has financial control if they can dictate the monetary details of a worker’s job. Per the IRS, financial control factors include: significant investment, unreimbursed expenses, opportunity for profit or loss, services available to the market, and method of payment.

• Significant Investment
  Significant investment speaks to if tools have been acquired to perform a specific job. There is no set amount of money that must be reached for significant investment to occur. Usually, independent contractors will supply their own equipment, whereas employees will be provided with the tools they need. However, plenty of jobs can’t be easily categorized in this way. For example, staff photojournalists may be required to use their own cameras and equipment. Mechanics may need to have their own tools at the shop. In cases like these, workers can be considered employees even though they’ve significantly invested in job-related equipment.
• Unreimbursed Expenses
  Unreiumbursed expenses are work-related payments for which employers do not pay back workers. While it is more typical for independent contractors to have unreimbursed expenses than employees, employees are not immune to such costs. (Think: teachers buying classroom supplies if a school fails to do so, or a remote employee paying for home internet.)
• Opportunity for Profit or Loss
  The opportunity for profit or loss of money can indicate whether someone is an employee or independent contractor. Usually, if a worker has significant risk or benefit on the table, they are an independent contractor. For employees, the employer will usually absorb any profit or loss.
• Services Available to the Market
  While all types of workers might offer their services to the market beyond a specific job, independent contractors are more likely to do so. They might maintain a website or office space, and may put ads out in the community.
• Method of Payment
  Method of payment determines how and when a worker is paid. Employees are usually promised specific wages, consistently paid (weekly, biweekly, monthly, or some other predetermined schedule). Independent contractors, on the other hand, are usually paid a set amount for a particular job. Contractors may also be paid hourly, though often not to exceed a certain amount. Payment may occur before work is performed, immediately after work is performed, or at some other later date. (For example, freelance writers may not be paid until after a work is published.)

Type of Relationship

Type of relationship is determined by how workers and businesses understand the nuances of their arrangement. The IRS identifies four worker/business relationship factors: written contracts, employee benefits, relationship permanency, and services provided as key business activity.

• Written Contracts
  Written contracts often state whether a worker is an employee or independent contractor. However, this does not guarantee that the IRS will classify the worker the same way the contract does. How a specific business relationship plays out will determine whether the IRS classifies the worker as an employee or independent contractor.
• Employee Benefits
  Employee benefits include health insurance, 401ks, paid time off, disability leave, and parental leave, among other potential perks. As the name suggests, employee benefits are usually reserved for employees. That said, not all businesses provide employee benefits, or they may only provide benefits for certain employees. For example, part-time employees are often not eligible for their business’s health insurance.
• Relationship Permanency
  Relationship permanency determines how long a business relationship is supposed to last. Independent contractors are usually hired for a set amount of time or to complete a specific project, whereas employees are generally hired without an end date.
• Services Provided as Key Business Activity
  How essential a worker’s services are to a business can help determine whether they’re an employee or independent contractor. The more key the services, the more likely the worker is an employee. For example, if an advertising agency hires a copywriter—a job that is arguably essential for the creation of advertisements—this worker would likely be considered an employee.

Note, however, that it can be more difficult to classify workers as independent contractors in some states than in others. California, for example, changed its independent contractor rules in 2020 with law AB5. To qualify as an independent contractor in that state, you must pass the “ABC test.” The test says you’re only an independent contractor if you’re free from control, do types of work outside the business’s typical purview, and have a separate business of your own.

What tax form do employees need?

Employees need to receive form W2. You’ll send copies to the IRS as well.

What tax form do independent contractors need?

Independent contractors need to receive form 1099-NEC. (Form 1099-MISC was the required filing until 2020.) Just like with W2s, you’ll also send copies to the IRS.

What is the deadline for distributing tax forms to workers?

The deadline for distributing tax forms to both employees and independent contractors is January 31. If January 31 falls on the weekend or a holiday, the deadline is the next business day.

What happens if I miss the filing deadline?

You’ll pay a fee. How big of a fee depends on how late you are. (The fees are the same whether you’re filing W2s or 1099s.)

• 30 days past the deadline: $50 per return, up to $556,500 for large businesses or $194,500 for small businesses.
• 31 days late until August 1: $110 per return up to $1,669,500 for large businesses or $556,500 for small businesses.
• After August 2 or never: $270 per return up to $3,339,000 for large businesses or $1,113,000 for small businesses.
• Intentional Disregard: $550 per return with no limit.