the difference between an Independent Contractor and an Employee?
Source = http://www.jashaw.com/solo/solo1.html
The difference primarily affects tax status. An independent contractor (IC) is not an
employee of anyone but himself (self employed) but instead invoices and is paid by the
client just as the client would pay any contractor. The client reports the payment to the
IRS on a form 1099 but does not withhold taxes or pay social security tax. Other laws and
regulations concerning employment, such as wage-hour (requiring overtime for certain
employees) and workers compensation do not apply.
A contract employee is an employee of a temporary service agency. That agency reports
the employee's earnings to the IRS on a form W-2, withholds Federal and state income tax,
and pays the employer's share of the social security tax. All federal and state employment
laws apply. The employee is not an employee of the client, for whom he performs his
services. That client actually is a client of the temporary services agency.
Advantages of 1099 status:
The IC has more freedom to negotiate his terms of payment than an employee. The various
state and federal laws regarding employment do protect workers from being taken advantage
of by employers. However, many professionals feel that they do not need such protection
and can take care of themselves. For example, many employees must be paid overtime of 1.5
times their regular pay for any time over 40 hours per week. However, this requirement
reduces the amount of work an employer will want an employee to perform (as intended by
the law). A consultant, working away from home, may prefer to work more than 40 hours per
week, allowing him to finish the project earlier, reducing the cost and allowing more time
at home. With IC status a consultant may negotiate pay at a flat hourly rate, encouraging
the client to allow more hours of work per week. Consultants have been known to entice the
client to allow (and make arraignments for) longer hours by offering a reduced rate for
overtime. Consultants can often make more money by quoting a fixed "lump sum"
price for a well defined project rather than being paid by the hour. This requires IC
The IC does not have withholding tax deducted from his pay check, although he must pay
quarterly estimated tax instead. Also, the client does not pay the employers share of
social security; that must be paid by the consultant (known as "self employment
tax"). These two items are a wash. However, an IC may often be able to deduct
expenses related to his consulting business that would not be available to an employee.
An employer must also pay certain required benefits, such as workers compensation
insurance. (while paid by the employer, the cost will reduce the amount available to pay
the consultant). Often the workers compensation insurance duplicates insurance the
consultant already has.
Advantages of W-2 status:
Working as an employee (contract or permanent, direct) also has advantages. Taxes are
taken out of each paycheck, and the employer (for a contractor, the agency) pays the
employer’s half of the social security tax. While this reduces the size of the pay
check, it eliminates the need for the employee to pay estimated taxes and file the
additional tax forms for a small business. For many people, this will eliminate the need
to hire an accountant or lawyer to prepare the taxes (although for a family there may be
other reasons to use a tax professional).
Often the decision of 1099 or W2 status is based on the circumstances of the work. If
you are going to work directly for a company to complete a project, and are to be paid a
fixed amount for the project, then there is usually no choice but 1099 status. The company
will issue a purchase order to you, you will complete the work and invoice the company.
On the other hand, if you are a contract employee working through a temp agency the
agency may not handle 1099 pay, or requires that you be incorporated to avoid a W-2.