Independent Contractor or Employee Decision

Small businesses decide how to treat workers, employees or independent contractors. This decision has major impacts to both the small business and the worker.  For the business, it is less work and less expensive to hire an independent contractor.  For the worker, it is less work and less expensive to be treated as an employee.

Independent Contractor or Employee Decision

Independent Contractor – It is fairly simple to hire a worker as an independent contractor.   The worker agrees to provide services under contract.  The contract details the job and amount of pay.  If the agreed upon pay is $10,000, then the business pays the worker $10,000.  There are no additional costs for the business.  The business will provide the worker IRS Form 1099-Misc at the end of the year.

Most workers don’t prefer independent contractor status.   The worker will be responsible for paying taxes on his or her own.   Also the worker will, generally, pay more taxes.  This can cause major issues for the worker if taxes are not carefully managed.

Employee – Workers treated as employees is more complicated for the business.  The small business will need to manage payroll.  Also, the business must file several forms throughout the year.  This includes IRS yearly forms, IRS quarterly forms, IRS new hire forms, Michigan quarterly forms, Michigan yearly forms, and Michigan new hire forms.  The amount of work for the small business is exponentially higher.

On average, it will cost the business about 12% more to treat workers as employees.   The small business will pay payroll taxes, unemployment compensation, workers compensation, payroll costs, and other employment costs.  If the business agrees to pay an employee $10,000, then the business will actually pay about $11,200.  This is $1,200 more compared to an independent contractor.

Most workers prefer to be treated as employees.  The worker will not have to carefully manage his or her taxes.  The business withholds taxes on behalf of the worker.  Most employees will get a tax refund at the end of the year.   Generally, the employee will pay less tax.

After you read this, a business owner will want to treat all workers as independent contractors. Workers will want to be treated as employees.  There are IRS rules for properly classifying workers.  The IRS rules are based on how much the business controls the worker.  In our next blog, we will review the control factors.

IRS Circular 230 Disclosure: To the extent this writing contains advice on a federal tax issue, the advice is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this communication.