NPR recently reported that about 20 percent of American jobs consist of workers under contract. Although these workers don't receive benefits from the job, they do have independence and a variable schedule. Contractors typically don't worry about losing their job, but they do report that their income varies.
Contractors and freelancers are more common today than ever before, but what is the difference? Does the designation matter?
Freelancer vs independent contractor
The contingent workforce consists of many people, from consultants to temps, freelancers to independent contractors and employees. Temps are workers hired by a staffing firm or for seasonal work, and employees work year-round.
Freelancers typically operate as their own business. Quite often, the term gets used interchangeably with independent contractor, but there can be some differences. A freelancer is considered a self-employed person who:
- Pays their own self-employment taxes
- Doesn't have any employees
- Sets their own rates
- Works remotely at their own location, wherever they choose
- Chooses which projects they want to work on
- Works with multiple clients or just one
Freelancers generally work on a project with expected outcomes for an agreed fee. The freelancer retains control over how to get the work done, working when and where they choose. Of course, the project is subject to agreed deadlines and outcomes. Freelancers may even subcontract the work to others, should they choose. The original organization does not control the work process.
An independent contractor often functions as a freelancer, but typically will work with one client for a longer time frame. In many cases, independent contractors work for an hourly rate. Furthermore, they might work through a third party or agency but can also work on their own.
If an independent contractor works on their own, they are responsible for taxes and insurance. If they work for an agency, that agency may be responsible for paying their taxes. It depends on the relationship between the worker and the organization.
Consultants may be freelancers, too. They could be independent contractors or employees. They come in to provide expertise on a specific project. But how they are classified depends on many different factors.
Determining worker classification
The IRS takes worker misclassification seriously. According to the IRS website, "The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done." There's no list that you can go through to classify a worker. It's based on the facts of each situation. Employers should consider three categories.
1. Behavioral control
The more control an employer has over the worker's behavior, the more likely a worker is considered an employee. This category includes:
- The degree of instruction, more details typically indicates that a worker is an employee, not an independent contractor.
- The number instructions given, like when and where work occurs and what tools to use.
- Training a worker on how to do a job indicates employment, not contractor status.
2. Financial control
In this category, the business should look at how much control the organization has over the business aspects of the job. Who invests in the equipment the worker uses? Does the worker have unreimbursed expenses? Independent contractors will more likely have expenses that a business won't reimburse. Can the worker seek out other business opportunities? If yes, then they are more likely an independent contractor.
Finally, employees typically earn wages for a period of time. Independent contractors generally receive a flat fee or an hourly rate for a job.
3. The relationship between the worker and business
Businesses that offer benefits, such as pension plans, vacations, and insurance typically do not give these benefits to independent contractors. Employees also have the expectation that the job will continue indefinitely, rather than a specific time frame or during a specific project. Note that a contract is not sufficient on its own merit to determine classification status, but it can be part of the overall discovery process.
The consequences of misclassifying an employee
When a misclassification of a worker occurs, the employer benefits by not having to pay Social Security and Medicare taxes for that worker. The worker is then responsible for their own federal withholding taxes. In the case of a freelancer prepared to pay their own taxes, this isn't a problem. When an unexpected tax bill shows up because of misclassification, it can cause a lot of problems.
Misclassifying workers as independent contractors when they should be an employee makes the employer liable for their employment taxes. The penalties for misclassification can be prohibitive, although the IRS does have a program that offers partial relief to businesses that reclassify workers correctly.
The IRS offers Form SS-8 to businesses to help employers classify their workers correctly. A misclassified worker can use Form 8919 to report the employee's share of taxes due to compensation.
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