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Overview
The term independent contractor is defined by the IRS as an individual who provides services where the payer of those services “has the right to control or direct only the result of the work and not what will be done and how it will be done.” (IRS - Independent Contractor Defined). Historically, and now more than ever, the classification of workers is a source of compliance risk for many employers. The lack of a clear nationwide standard for what constitutes an employee has left states to craft disparate statutes, with some states like California and Massachusetts setting the threshold for independent contractor status higher than others. The explosion of the gig economy has further challenged interpretations of what constitutes an independent contractor versus an employee. Yet all employers bear substantial risk of private litigation or government enforcement actions for misclassification of workers.
Contractor vs Employee
While employers should consult with legal counsel before making worker classification decisions, it is imperative that payroll products be designed to clearly distinguish between employees and independent contractors, to accommodate the legal requirements for each, and to adopt prevailing standards and terminology for each so as to avoid contributing to any confusion or misunderstanding regarding a worker’s status. Should an employee classification be challenged in litigation, courts will often rely on payroll records to help determine if a worker has been misclassified.
The table below details some differences in the legal requirements, forms and processes for employees and independent contractors.
DESCRIPTION | EMPLOYEE | CONTRACTOR |
Employment Laws | Covered under both federal and state employment and labor laws | Not covered by employment and labor laws |
Hiring Practice | Employee onboarding is required to collect information such as date of birth, marital status, and citizenship status | A contract will normally serve as the beginning of the work relationship, which will usually include a Statement of Work approved by the legal or procurement section of the business |
Tax Documents | IRS form W-4 is required where the employee’s name, address, Social Security number, tax filing status, and number of exemptions must be provided | IRS Form W-9 is required where the contractor’s name, address, Taxpayer Identification Number, and certification about backup withholding is required |
Payer’s Tax Reporting Requirements | All money paid during the tax year is reported on IRS Form W-2 | Payments of $600 or more are reported IRS Form 1099-NEC |
Reporting to Other Agencies | Employer must report for purposes of federal and state unemployment insurance | No reports are sent related to federal and state unemployment insurance |
Value of Work or Contract | Base pay standard is usually hourly rate or salary with no anticipated end date | While hourly pay is possible, contract may be for a total amount that has a specific end date or a total amount to be paid upon completion of certain work or projects |
What's Next?
Check out all of our resources for integrated Payroll in the Master Guide!