A simple question to answer, right? Not so much anymore. The sharing economy has disrupted the once distinct dynamic between 1099 contractors and W-2 employees. With legislators attempting to redraw the line, it’s more important than ever for both businesses and their workforce to understand the difference.
A legal perspective
The IRS outlines the difference between employee and contractor as being defined by the degree of control and independence that exists in the relationship. This can be broken down into three separate indicators: behavioral, financial and the type of relationship.
The IRS is quick to state: “There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.”
A Financial perspective
Asking questions about whether an individual is a contractor or an employee of your small business takes on added importance when financial issues are considered. Contractors are generally cheaper than employees with one caveat: make sure you’ve cleared up that it is a contractor rather than employee. The IRS doesn’t take kindly to companies avoiding payroll taxes.
Why this financial disparity between employees and contractors? Well, businesses must withhold income taxes, social security and medicare taxes for employees as well as pay unemployment tax on employees’ salaries. No such commitments exist in the contractor relationship.
Bear in mind too that someone being a contractor to your company doesn’t always make them cheaper. There are several issues to consider: a low-cost job done badly may cost more in the long run to repair damage done; also consider the time that you devote to managing each – very often, perhaps counter-intuitively – contractors will take up more of your time than common law employees.
As the Economist noted in 2015: “A recent study by the Freelancers Union, a pressure group for freelance workers, suggests that one in three members of the American workforce (and a higher proportion of younger people) do some freelance work.”
If you’re finding it difficult to define your professional relationship with someone (i.e. deliberating over whether they’re a contractor or employee), the chances are that they’re an employee. The greatest money-saver of all might be to contact the IRS or a similar body and get their perspective on the issue.
The good news for small business owners is that you’ve now got so many options to choose from. As always, think about your short- and long-term requirements and costs; a freelancer might work perfectly for a one-off job but if it’s a task that you’re going to need to be carried out for the foreseeable future, a full-time employee might work better. Above all – be creative: the ones who are benefitting the most from the freelancer revolution are the ones who were willing to look outside the box of traditional employment boundaries.
 See: Knaup, A. and Piazza, M. (2007), “Business employment dynamics data: survival and longevity, II.” Bureau of Labour Statistics Monthly Labor Review, September 2007.  See: Cassar, G. (2010), “Are individuals entering self-employment overly optimistic? an empirical test of plans and projections on nascent entrepreneur expectations.” Strategic Management Journal, Vol. 31, Issue 8, pp. 822-840  https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee  The Economist (2015), “There’s an app for that.” January 3rd, 2015.