What is the difference between an Employee and an Independent Contractor?
Generally defined, an employee is an individual who provides a service for wages, under the direction and control of a business owned by someone else. By contrast, an independent contractor is a self-employed individual who pursues an independent business and who is not subject to the direction and control of the employer.
Employees are often afforded workers compensation and other benefits, such as healthcare, retirement, training and reimbursement of business expenses. Independent contractors are usually not entitled to such benefits.
What does being an Independent contractor mean for my taxes?
In short, independent contractors are responsible for paying their own taxes.
Employers and employees are responsible for paying payroll taxes and income tax withholding. Federal Insurance Contributions Act (“FICA”) taxes are imposed to fund Social Security and Medicare. Employers are required to pay half of each employee’s FICA taxes. The employer will deduct the employee’s portion of the tax from payroll and pay FICA taxes, generally on a monthly basis. Additionally, employers will withhold an additional amount as a prepayment for income taxes. When an employee files his or her taxes, this prepayment reduces the employee’s tax liability.
Independent contractors do not have the benefit of an employer paying half of the FICA taxes or deducting for income taxes. Independent contractors are required to pay the full amount of these taxes called Self-Employment taxes. (note: a portion of self-employment taxes can be deducted as a business expense for independent contractors.)
What about minimum wage and overtime?
Federal and state regulations regarding minimum wage and overtime pay are designed to protect employees. Independent contractors are not employees and are not given such protections. Ideally, an independent contractor will bargain for the best rate to perform the service. The employer and independent contractor will agree on the total amount of the service to be provided.
Who determines my employee classification?
Employers are responsible for classifying employees correctly. The IRS and TWC have a 20-point test used to determine whether a worker has been classified properly. The key issue is who has direction and control of the means and methods of the work. If an employer can direct or control things such as how a job duty is to be performed, where the job is done and how many hours an employee works, then chances are it is an employer-employee relationship. Independent contractors are masters of his or her own schedule. Employers can direct a result but not the means and methods of achieving such result.
The proper classification cannot be modified by agreement between the worker and employer. Also, the employee’s title does not determine the proper classification. The dynamics of the work relationship will govern the proper classifications.
What if I have been misclassified?
Just because your employer classifies you as an independent contractor doesn’t mean that classification is correct. Many employers misclassify employees as independent contractors often to reduce costs or simply because they do not understand the law. Misclassified employees miss out on benefits to which they are entitled, such as minimum wage, overtime, family and medical leave and unemployment insurance.
If you feel that your employer has misclassified your employee status, then you may file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS to research and return a determination on the correct employee classification. You may also file a complaint with the Texas Workforce Commission (“TWC.”)
If the IRS or TWC determines you have been misclassified, the agency can require that the employer properly classify you and pay any losses incurred as a result of the misclassification, including, benefits and overtime compensation. Additionally, an employee can file private lawsuit to recover double the amount of back pay as actual and liquidated damages.
How long do I have to take action?
A Form SS-8 can only be submitted for an open tax year. If the form is submitted for a tax year for which the statute of limitation on the return has expired, then the IRS will not issue a determination letter.
To file a claim with the TWC, you have 2 years of the violation from which you are claiming back pay to file a charge of unpaid wages, unless there is a willful violation on behalf of the employer where there is a 3 year statute of limitations.
Contact us if you believe you have been misclassified as an independent contractor.