More and more Americans are joining the gig economy. In a recent study by Paychex, the growth of independent contractors was shown to be outpacing employee hiring rates. In fact, one in 10 Americans are independent contractors, according to the Department of Labor. For businesses, a significant part of their recruitment decision lies in understanding the difference between an employee and contractor- and what it would mean for their business. From their entitlement to employer benefits like workers compensations to the applicable labor laws, outlining the business and legal ramifications can determine their compliance and recruitment strategy in the coming years.

Control Of Skills And Clientele

A key differentiator between a worker and freelancer is their control and classification. Misclassification of the two can cause serious financial and legal repercussions, so businesses must separate the two before assessing their recruitment needs and budget. For instance, in 2015 the state of California ruled Uber drivers to be employees, not contractors as the company initially asserted. The misclassification by Uber eventually led to a lawsuit and settlement cost of $100 million for drivers in California and Massachusetts.

When it comes to the control aspect of employment, employers should be dictating most of the terms of their work like work hours, methodology, provision of tools, or work location. However, many independent contractors are small businesses or sole-traders themselves. This means they have the right and freedom to work with multiple clients at once unless it signals a conflict of interest. Therefore, the contractor-employer relationship takes the form of a business to business relationship.

Employee Protection And Labor Laws

Independent contractors are also not covered by certain employment laws in the workplace. Currently, the U.S. Department of Labor enforces 180 different labor laws. However, a significant percentage of them do not apply to businesses with contractors. Federal employment laws like the Fair Labor Standards Act (FLSA) and the Occupational Safety and Health Administration of 1970 implemented by OSHA all apply to employees and provide them with protection against various workplace hazards.

This also applies to a worker’s entitlement to benefits. For instance, the Employers Shared Responsibility Payment regulation stipulates that companies with 50 or more full-time employees must offer their employees at least basic medical instance coverage. However, since most contractors are classified as self-employed, they are exempt from this rule. This often leads to many independent contractors missing out on benefits like employer-provided healthcare insurance, workers’ compensation, social security, and 401(k) contributions. For businesses, this equates to lower recruitment and employee costs due to the reduced need to provide benefits.

Taxation And Reporting Obligations

Lastly, key difference businesses should consider when deciding between employees and contractors is its impact on its federal tax obligations. The Internal Revenue Service uses a right to control tests to determine a business’s tax liability for employees and contractors. Employees are entitled to a salary whilst contractors submit invoices for their specified jobs. Businesses with employees are also responsible for withholding federal income tax, social security, and Medicare taxes from their wages. They are also required to match these amounts as an employer. However, this is not required if the business is employing a contractor.

If they choose to employ a contractor, businesses should ask that they complete a Form W-9, which helps the IRS identify the contractor by use of the contractor taxpayer’s identification number. Contractors that are paid over $600 for their services in a year are required to complete Form 1099-MISC. Since contractors are responsible for paying their taxes at the end of the tax period, they can also use the right to control test accessible on the IRS website, to help them clarify their tax reporting responsibilities as a contractor and self-employed individual. Lastly, businesses with employees must pay FUTA, which is the federal unemployment tax. This is levied directly on the employer’s income and not paid for by any employees. For 2020, the FUTA rate is 6 percent and is applied to the first $7,000 earned by each employee of the business.

Employees and contractors both have their own upsides and uses in business. Figuring out the perfect fit and your legal requirements of each one can help your business make the best decision for its recruitment needs.

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