Independent Contractors VS Employees : What Is The Difference?

Stay Ahead of Law Changes & Protect Yourself Against Being Audited: Corporate Transparency Act and Reasonable Compensation

Independent Contractors Vs. Employees

What is the difference in Independent Contractors VS Employees 

If you have found yourself asking why your boss has paid you as a 1099 independent contractor instead of a w-2 employee, look no further. There are various tax implications for individuals who receive these, and reasons for an employer to do this, but first you must understand the differences between the two. 

What is a 1099 Independent Contractor? 

A 1099 form is issued to an “independent contractor” at the end of the year, rather than the common W-2 form that most employees receive. The differences between the two are much more than the different form numbers. An independent contractor is often simply defined as an individual or sometimes even a company that executes a service for another person or company. Under this professional classification contractors are seen as “self-employed”. 

Furthermore, this classification comes with many benefits such as: the freedom to choose which services they will offer, their daily schedule, their workplace, their work supplies, their work tools and expenses, and many other things they may need to accomplish their service. In optimal circumstances they have a professional contract in which their scope of work is defined. This is the primary distinction between a typical employee and an independent contractor. 

What is a W2 Employee? 

Conversely, a traditional W-2 employee works for an indefinite period. The employer controls services performed, their role, their schedule, and provides all materials associated with their work. Before the popularity of “hybrid scheduling” or “work from home”, it was commonplace for employers to facilitate a physical location for their employees to work.   

How do I know W2 or 1099? 

The IRS has issued a set of rules and criteria for determining a worker’s status called the “Common Law Rules” for employees and employers to better understand how you should be classified or how employers should classify their workers. This set of rules is broken into three distinct categories: Behavioral Control, Financial Control, and Type of Relationship.  

1.Behavioral Control 

 This first criteria refers to the level of control an employer has over an individual’s work or service. This means a worker must be classified as an employee when they are instructed when, where and how to 

work. 

 According to the IRS, behavioral controls include: 

  • Type of Instructions Given: If the employer commands when, where, and how to work, it suggests an employer-employee relationship. 
  • Degree of Instruction: The more detailed the instructions, the more control the business owner has over a worker. 
  • Evaluation Systems: If an employee requires to be evaluated by the company’s owner, this indicates employee status. 
  • Training: If the company provides the worker with job training, this means the company wants. the job done in a specific way which is evidence the worker is an employee. Independent contractors work according on their own experience, training, and methodology.  

2.Financial Control 

This criterion refers to factors that show the degree of the control the company’s owner has over a worker economically. 

 According to the IRS, financial control includes: 

  • Significant Investment: An independent contractor commonly has a significant investment in the equipment they use. An employee does not. 
  • Unreimbursed Expenses: Commonly independent contractors have more unreimbursed costs than employees. 
  • Opportunity for Profit or Loss: If a worker has a significant investment in the tools and equipment, the opportunity to make or lose money increases. This indicates independent contractor status. 
  • Services Available to the Market: An independent contractor is free to seek out multiple, and most likely simultaneous, business opportunities. 
  • Method of Payment: Employees are guaranteed a regular hourly, weekly wage amount (or any other scheduled). Independent contractors usually provide an invoice that list a fee, or an hourly rate. 

 3.Type of Relationship 

This criterion refers to factors that illustrate how a worker and business perceive their working relationship.  

According to the IRS, these factors include: 

  • Written Contracts: Even if the worker’s classification is in a written agreement or statement, the IRS does not see this as a sufficient means of determining the worker’s status. It is the nature of how the parties work together that determines if a worker is an employee or an independent contractor. 
  • Employee Benefits: Businesses generally do not provide employee benefits to independent contractors. 
  • Permanency of the Relationship: A worker who expects the relationship to continue  indefinitely is typically an employee. 
  • Services Provided as Key Activity of the Business: A worker who provides services integral to business operation such as an attorney working for a law firm, is more likely directed by his or her employer (employee status). 

How to prepare for taxes as an Independent Contractor? 

As an independent contractor you are responsible for filing a Schedule C on your individual tax return and paying quarterly taxes if applicable to the amount you earn. On top of your federal state and income tax that you already must pay, as an independent contractor you also must pay an additional 15.3% in self employment taxes. This tax consists of the Social Security and Medicare taxes that would usually be withheld by an employer of a salaried or W-2 employee.  

 This additional self employment tax can get very costly, so check out our blog post on how to avoid this additional tax by setting up an S Corp HERE. (planning to post around 8/23/22)

In order to determine how much you must pay in self employment and income taxes you must calculate your net profit. To do so you must subtract your business expenses from your business income. If your expenses are less than your income, the difference is net profit and become part of your income on the first page of your form 1040 or 1040-SR. 

When a payment to someone who is not an employee (such as a subcontractor, attorney or accountant) is more than $600 for services rendered during the calendar year, a form 1099-NEC needs to be completed and provided to the independent contractor by January 31 of the following payment. 

How to prepare for taxes as an employee? 

Consequently, knowing your employment status and how to properly classify your workers is vital to maintaining the compliance of your business and knowing the best route to prepare for your taxes.  

 W-2 employees have much simpler tax requirements and preparation for their tax returns. Their taxes can easily be mitigated by ensuring proper withholding throughout the year depending on their annual salary and earnings. 

While 1099 employees or independent contractors are subject to additional taxes and scrutiny by the IRS, they are also allowed more deductions and tax credits depending on their industry that can help them to build a successful business. The best way for people who fall under this classification to prepare for taxes, is to make sure they are saving enough money to pay their taxes, making quarterly payments, keeping accurate records of all their expenses (mileage, materials, legal fees, office expenses, etc.), and working with knowledgeable professionals for tax planning.  

With the counsel of a seasoned accountant, like one of our tax advisors at Molen & Associates, you can succeed. Call us today, seriously. You’ve read this far; you know you need us! 

Edgar Castillo 

Tax Advisory & Accountant 

The Molen & Associates Difference

Mike Forsyth

“Super helpful and timely. This is our first year with them and we look forward to trusting them with our taxes and business books for years to come.”

Caitlin Daulong

“Molen & Associates is amazing! They run an incredibly streamlined process, which makes filing taxes a breeze. So impressed with their attention to detail, organization, and swift execution every year. Cannot recommend them enough!”

Sy Sahrai

“I’ve been with Mr. Molen’s company for few years and I felt treated like family respect and dignity. They are caring, professional and honest, which hard to find these days. Love working with them.”

Gig Economy Taxation: a Detailed Overview

Gig Economy Taxation: a Detailed Overview Reporting Income as a Gig Worker Gig economy workers must report all income earned from their endeavors. This includes, but is not limited to: Earnings from part-time, temporary, or side gigs. Income not reported on...

Standard Deduction vs. Itemizing: A Comprehensive Guide for Small Business Owners and Self-Employed Individuals

Standard Deduction vs. Itemizing: A Comprehensive Guide for Small Business Owners and Self-Employed Individuals   As tax season approaches, one of the most significant decisions you’ll face as a small business owner or self-employed individual is whether to take...

Real Estate and Taxes: A Comprehensive Guide

Real Estate and Taxes: A Comprehensive Guide Real estate taxation is a multifaceted topic that encompasses various forms of taxes, including income tax, property tax, and sometimes even sales tax. Whether you’re dealing with personal or business real estate,...

Steps to Filing a Tax Extension

Is Filing an Extension Bad?   We get this question probably a thousand times a year. An extension is not inherently bad, it is truly personal preference. An extension will not increase your risk for an audit or red flag your return with the IRS. In fact, it is...

How to Pay Your Child From Your Business

How To Pay Your Children From Your Business Paying your children through your business can be a strategic way to manage your business's taxable income, while also providing your children with income and potentially teaching them about the value of work.  While it is a...

Tax Tips for Newlyweds

Tax & Financial Tips for Newlyweds in Houston Marriage is a significant milestone that not only unites two individuals in partnership, but in most cases, also merges their financial and tax situations. For newlyweds in Houston, understanding the tax implications...

Self-Employment Taxes: A Deeper Dive

Self-Employment Taxes: A Deeper Dive Self-employment taxes are a critical component of the tax system in the United States, impacting individuals who work for themselves. Understanding the nuances of these taxes can help self-employed individuals plan and manage their...

Education Tax Benefits: Maximizing Savings with Credits and Deductions

Education Tax Benefits: Maximizing Savings with Credits and Deductions Navigating the complexities of tax season can be daunting, but for those bearing the costs of higher education, there are valuable tax benefits that can ease the financial burden. Among these are...

How to request Individual Penalty Abatement

How to Request Penalty Abatement Penalty abatement is a great way to help reduce your client's tax debt. Here's how you can request apenalty abatement from the IRS. Let’s say you’ve determined that your client is eligible for a penalty abatement to help reduce their...

Understanding the Child Tax Credit for 2023

Understanding the Child Tax Credit for 2023 The Child Tax Credit (CTC) is a significant provision in the U.S. tax code designed to offer financial relief to families with qualifying children. As we navigate the 2023 tax year, it’s crucial to understand the current...

Request an Appointment Today

15 + 8 =

Call us at

Pin It on Pinterest

Share This