The Differences Between Being an Independent Contractor vs. an Employee

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As an independent contractor (IC), you are probably well-aware of the fringe benefits inherent with that status, including setting your own hours and pay, working where you wish and only on agreed-upon (i.e., contracted) projects, and seeking out additional business opportunities at your discretion. This is what “being your own boss” is all about; in essence you are own your own employer and thus, self-employed.

I’ve always looked at being an IC versus an employee as being single versus married. While I much prefer being single to married, there are advantages and disadvantages to either state of being (as I’m sure many of you well know). There are also ways in which various companies/clients can take advantage of your IC status if you’re not careful. Here are some things to keep in mind as you go about securing contract work and getting hired by clients:

Taxes

The IRS has a very strict definition of who is an IC or an employee based on how taxes are paid. If you are an IC, federal income, Social Security and Medicare taxes are solely your responsibility and are generally paid quarterly as self-employment tax. At the end of the year, your clients will typically send you a 1099-MISC form where your gross pay is provided. Click here to learn more about paying taxes as a freelancer.

If you are an employee, your employer takes out a certain weekly or monthly sum from your pay and pays your taxes for you. Your employer also matches and pays the amount you pay towards Social Security and Medicare. This means that, if you are an IC and therefore your own employer, you must send additional matching Social Security and Medicare funds to the IRS. At the end of the year, your employer will typically send you a W-2 form where the taxes withheld are specified as different line items.

As an IC, you are responsible for paying your own taxes plus your employer’s- meaning you- taxes. This is one big reason why ICs command higher per hour rates than employees (Yes, it’s certainly more expensive being single than being married). However, some unscrupulous clients may try to take advantage of your freelance status by calling you an employee in order to pay you less money. These clients will not pay your taxes, of course- leaving you with quite a nasty surprise come tax time.

Conversely, if you are hired on as an employee, your employer may misclassify you as an IC. Misclassification of employees is subject to tax penalties by the IRS, so be sure you know who is paying the taxes before you simply agree with what your client/employer tells you.

Investment

Employees are looked upon as more permanent (i.e., married) fixtures in a company and thus are typically provided with company-sponsored training and work materials. If an employee travels anywhere for the company and has to pay for certain expenses (e.g., food, gas) out-of-pocket, those expenses are usually reimbursed. Most employees also receive company benefits such as subsidized health insurance, retirement, sick pay, etc. There are certainly a lot of benefits to being married!

An IC is typically expected to pay for his/her own training and work materials. In fact, clients usually assume that the given IC will have already prepared for the job by taking the necessary training and purchasing materials beforehand. In most cases, IC expenses are not reimbursed- which means that you need to carefully consider how much a contract will cost you out-of-pocket before simply agreeing to it.

The high cost of doing contract work is another reason why IC rates are typically higher than those of employees. For example, if a contract job requires that you fly to a different city on a weekly basis and even stay there for several days, you would not be out of line asking $100/hour for your rate. Likewise, part of your IC rate goes to pay for your own business expenses such as health insurance and an IRA. Furthermore, unlike an employee, you don’t make any money if you’re out sick or on vacation.

Behavioral control

When you’re an employee, just as when you’re married, your behavior is more strictly controlled. If you are an employee, your employer usually controls when and where you work. From time to time, you may be expected to perform tasks that are not listed in your job description and/or put in extra (and often unpaid) hours. The methods (e.g., SOPs) and technologies by which you conduct your work may be controlled by your employer.

As an employee, you may also be limited or even forbidden from pursuing other business opportunities (i.e., cheating), especially if those business opportunities are in the same market as or in direct competition with your employer’s business. Often known as non-competition clauses, such employment terms can severely limit the amount of money you earn or how far you excel in your field of expertise.

As an IC, you are much more free to play the field and do (i.e., date) as you please. Obviously, one of the biggest draws of being an IC is that you work for yourself and make your own rules. Punching a clock, working 9-to-5, etc…these aspects all disappear once you’re your own boss…until you realize that you can be your own worst boss. Because your potential to make money is now unlimited, you can easily go from working 40 hours per week to working 60, 80 or even more.

Another danger is that, for fear of losing your current clients, you start agreeing to their requests that you work during certain times of the day or even at their places of employment. When you allow your clients to treat you as an employee without the matching employee benefits, you do yourself a great disservice and lose out on why you became a freelancer in the first place. Also, requiring that an IC work at certain times of the day or at certain locations (i.e., treating ICs as employees) is actually illegal and can be punished in a court of law, as is evidenced by the recent $1.3 million kgb USA settlement.

The bottom line here is that, if your clients really want you to be an employee (i.e., married), they should discuss an employment contract (i.e., “put a ring on it”) with you- complete with benefits like health insurance coverage, 401(k), paid time off, etc.

Being an IC or an employee…which one is better?

Debating about whether being an IC versus an employee is better is a lot like debating if the single or married life is better: There are advantages and disadvantages with each position. Depending on where you are in life and your other obligations or realities (e.g., young children, poor health, educational needs), being an IC-  or an employee- might be more suitable for you.

In the end, you’re not a “sell-out” if you decide to become an employee. Conversely,  you may like the risks and challenges that arise from taking the IC route. Keep in mind that no role is permanent you can always switch gears. Finally, you might even wish for the best of both worlds and become both an employee and a freelancer.

 

Photo credit by Philip Taylor PT

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