Independent Contractor & Employee - What Is The Difference?
A lot, at least from the tax perspective.
Let’s start with some definitions.
EMPLOYEE: An employee is hired by a company and is added to the company payroll. When an employee is hired, the company will collect a W-4 (an IRS tax form) in order to calculate payroll tax withholding.
INDEPENDENT CONTRACTOR: An independent contractor (IC) provides services to a company. An IC provides a W-9 to the company to certify tax identification number and entity type (sole proprietor, partnership, corporation).
Now, assume both the employee and the IC start on Monday and both are to be paid $50/hr. After working a full 40 hour week, it is Friday and both are paid.
The EMPLOYEE submits a timecard and receives a paycheck
The INDEPENDENT CONTRACTOR submits an invoice and receives a check.
On the surface, it looks like the INDEPENDENT CONTRACTOR is getting the better deal, but don’t be fooled (be educated).
The EMPLOYEE’s check is smaller due to taxes being withheld, both income tax and payroll tax. These taxes are removed from the check by the employer then sent to the IRS and the State on behalf of the employee.
The INDEPENDENT CONTRACTOR’s check is larger because the taxes are NOT being withheld. The INDEPENDENT CONTRACTOR is responsible for withholding and remitting income tax and payroll tax themselves – big difference.
Another big difference is the group of taxes called SELF EMPLOYMENT TAXES – otherwise known as social security and Medicare. Why the big difference; INDEPENDENT CONTRACTORS pay almost DOUBLE what employees pay for social security and Medicare.
Before you get out your tablet and whip out an email to your congressman about the inequities of the tax system, let's go over some details.
If you are an EMPLOYEE, your paystub is a collection of nonsensical initials. One of those initials is called FICA, which in short hand means Social Security and Medicare. Let's take one at a time.
SOCIAL SECURITY: As an employee, 6.2% of your wages are withheld and remitted to the IRS for eventual deposit into the Social Security Trust Fund so you can use it as supplemental income when you retire. What most people do not know, is that your employer also pays a matching 6.2% of your wages to the IRS for eventual deposit into the Social Security Trust Fund. So, the employee's 6.2% plus the employer 6.2% equals the 12.4% of your wages for social security.
MEDICARE: Roughly the same situation except the percentages are different and the fund is administered by the US Government instead of Social Security Trust Fund. The EMPLOYEE pays 1.45% and the employer pays 1.45% for a total of 2.9%.
When you are an INDEPENDENT CONTRACTOR, you are responsible for BOTH the employee portion and the employer portion.
So for INDEPENDENT CONTRACTORS, your payroll tax percentages are:
Social Security 12.4%
And income tax, same as if you are an EMPLOYEE, will be based on the tax brackets you are in. So again, don't be fooled (be educated) when it comes to tax obligations of an
INDEPENDENT CONTRACTOR since all hourly rates are not created equal.