Independent Contractor versus Employee – Cost Differences

We reviewed the different filing requirements for treating workers as independent contractors compared to employees.  Next we will review the cost differences between the two classifications.

Small businesses prefer to treat workers as independent contractors because it is less expensive and less work.   Generally, the only expense for classifying workers as independent contractors is compensation.  In contrast, the small business is responsible for paying workers classified as employees compensation, Social Security tax, Medicare tax, IRS unemployment tax (FUTA), and state unemployment tax.

Independent Contractor Example
Business treats a worker as an independent contractor and pays the worker $10,000 of compensation for services provided.  The only expense to the business is the $10,000 of compensation.

Total Cost to Business $10,000

Employee Example
Business treats a worker as an employee and pays the worker $10,000 of compensation for services provided.

Expense Tax Rate Tax Amount
Compensation Cost* 10,000
Employer Portion of Social Security (FICA) 6.2% 620
Employer Portion of Medicare (FICA) 1.45% 145
IRS Federal Unemployment Tax (FUTA) on first $7,000 of wages 0.6% 42
Michigan Unemployment Tax on the first $9,000 of wages 2.7% 243
Total Cost to Business $11,050

Federal Insurance Contributions Act (FICA) is composed of Social Security and Medicare taxes.

* Total Compensation cost includes employee withholding, employee share of Social Security, and employee share of Medicare.
** The Michigan Unemployment Tax rate varies based on the business.  The rate can between 0.06% and 10.3%.  Businesses with higher employee turnover will have higher rates.  The first year rate was used in this example which is 2.7%.

In this example, the additional cost for treating a worker as an employee compared to an independent employee is $1,050 (11,050 – 10,000 = $1,050).  The cost impact to the business is about 10% greater.  This does not include other costs for treating workers as employees such as workers compensation, insurance or legal costs.

Most businesses would like to classify all workers as independent contractors because it is less work and less expensive.  But there are strict rules for determining whether workers can be treated as independent contractors versus employees.  In the next blog, we will review the IRS tax rules for determining if your workers should be treated as employees or independent contractors.

Reviewing worker classification can be complicated.  If you need assistance on determining worker classification, call ALG Tax Solutions 855-MI-Tax-Help (855-648-2943), provide your contact information online, or click Ask Your Question.

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.