Many of those who’ve lost their jobs during the recession want to turn their backs on corporate America and be their own boss. But before they trade their employee status for that of an independent contractor, they need to know the pros and cons of each.
Generally, an employer-employee relationship exists if a worker performs services that can be legally controlled by an employer, such as what will be done and how it will be done, even if the worker is given freedom of action. An individual is an independent contractor if the person paying him or her 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.
Other considerations that are made when determining whether someone is an employee or an independent contractor include each party’s level of loss in the working relationship; who is paying for materials, supplies, and equipment; the type of skill required; and the permanence of the position.
According to the Internal Revenue Service, a business owner generally must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on an employee’s wages, but they do not have any of those responsibilities when they work with an independent contractor.
In the past, many people considered being an employee a more stable and steady type of work arrangement compared to that of being self-employed, but since the Great Recession, these beliefs are changing. Of course, there are certain benefits (and downsides) to each type of relationship.
Employees enjoy certain perks, even some that they aren’t always aware of. They usually enjoy a relatively steady income and do not have to provide their own equipment, tools, and supplies to do their job. Their employer is responsible for marketing, bringing in business, and providing work for them to do.
Employees may be eligible for employer-sponsored benefit plans including health, life, dental and vision insurance and retirement benefits, if their employer chooses to offer them. They may also receive paid time off in the form of annual, sick leave, personal, and bereavement leave, and also receive certain paid holidays off each year. Employers may also pay for employee training, travel, and memberships to professional organizations.
Although employees pay taxes, their employers facilitate much of the process by withholding federal income tax, Social Security, unemployment, and Medicare taxes from their employees’ wages. They also pay workers compensation insurance premiums and provide a match to the amount of Social Security and Medicare taxes paid by employees.
On the downside, employees usually do not have a tremendous amount of freedom, cannot set their own schedules, decide what work they want to do (and what they don’t), and give themselves a raise when they feel they deserve it. In most states, they are employed at-will, meaning that they can be terminated or have their pay or benefits cut by their employer at any time for any reason except an illegal one, with no legal consequences to the employer.
The main advantages to being an independent contractor are independence and control. Independent contractors are able to set their own work hours, rates, and accept or decline work according to their preferences and schedule. Although they must handle their own marketing and promotion, find their own clients, and ultimately build their own businesses, independent contractors typically have more control over their income than employees since they are their own bosses and can independently decide to raise their rates, cut their expenses, take on more work, and ramp up their marketing efforts when necessary.
Unlike employees, who usually have minimal tax write-offs, independent contractors can deduct many of their business-related expenses, including travel, vehicles, equipment, utilities, and supply costs. According to Bloomberg BusinessWeek, small business owners often miss legitimate write-offs, including home office expenses, cell phone charges (if used for business), and the cost of business-related books, magazines, and newspaper subscriptions.
An independent contractor has freedom, but freedom does not come without responsibilities. Because independent contractors do not have employers to withhold federal income tax, Social Security, and Medicare taxes from their earnings for them, they must handle those responsibilities on their own. Many make quarterly estimated tax payments to the IRS to avoid having to come up with an entire year’s worth of income tax at tax time.
An independent contractor’s earnings are subject to self-employment tax, which is basically Social Security and Medicare tax without the employer match. According to IRS.gov, the self-employment tax rate for income earned in calendar year 2011 and 2012 was 13.3% (10.4% for Social Security and 2.9% for Medicare), thanks to the 2010 Tax Relief Act, which reduced self-employment tax by 2% from 2010 levels.
Lack of access to employee benefits is something that prevents many individuals from making the leap to self-employment. Independent contractors must buy their own health insurance and fund their own retirement plans, and do not receive paid holidays, vacation, or sick leave. They must also buy their own equipment and supplies and pay their own travel expenses, although many of these costs can be written off on their tax return each year.
Which Is Better? It Depends
Whether a worker is better suited to be an employee or an independent contractor depends on their individual strengths and weaknesses. For highly motivated self-starters who don’t need (or want) a boss to report to, self-employment can be an excellent choice. But for those who function better with supervision, a set schedule, and don’t want to deal with marketing, taxes, and business records, an employee status might be the right fit for them.
Jan Hill is a professional journalist and legal blogger for the Law Offices of Daniel R. Rosen, a Denver law firm handling personal injury cases for over 25 years. For more information, please contact us at 1400 16th Street, Suite 400, Denver, CO 80202 or (303) 454-8000.