Employee Versus Independent Contractors: What Is The Difference? Free Sample

The purpose of this paper is to differentiate between an employee versus independent contractor and then illustrate the difference between these in the tax based issues. Competition from both domestic and international market has forced the companies in U. S. to lower down their operating costs while maintaining quality standards, productivity and efficiency level and this is most fluently and successfully done through cutting down labor costs in the U. S. employment market.

Downsizing and reengineering are becoming standard operating practices. Many companies since quite a time are achieving this objective through terminating their permanent employees and hiring the independent contractors on contract basis. In this way they are exempted from tax payments as well as the rising health and other benefits costs paid to the permanent employees in U. S. However, there can be major legal and tax risks associated with such practices if they violate the Internal Revenue Service’s definition of an employee.

One of the IRS’s most controversial issues in recent years is the reclassification of a worker’s status from an employee to an independent contractor. The IRS claims it loses millions of dollars each year due to such improper classifications, particularly with the number of independent contractors in the U. S. at five million and rising. An advantage of labeling a worker as an independent contractor is that it lowers an employer’s tax obligation, since the employer does not have to pay the contractor’s Federal Insurance Contribution Act (FICA) or Federal Unemployment Tax Act (FUTA) taxes.

Moreover, administrative costs of complying with the tax laws are greatly reduced because the employer is not required by law to provide employee benefits (vacation pay, sick leave, health insurance, pension contributions) to an independent contractor. One of the most perplexing aspects of the debate is the legal view regarding how a worker should be classified. The common law classification between the two types is often contradictory and vague.

No single rule or test distinguishes whether a worker is an employee or an independent contractor. This is primarily because the relationship between a company and its workers is unique. Every decision of whether a worker is an employee or a contractor must be made on a case-by-case basis. Employee versus Independent Contractor The term “employee” is defined in three different sections of the IRS code relating to employment taxes.

The Section 3121(d) definition for FICA tax purposes contains the broadest of the three: a corporate officer; an agent or commission driver who distributes meat, vegetables, fruit, bakery goods, beverages (other than milk), laundry, or dry cleaning; a full-time life insurance salesman; a home worker performing work under the specifications of the person who provides the materials or goods, which are required to be returned to such person or a person designated; or a traveling salesman, engaged full-time to solicit orders for his principal.

With the exception of the corporate officer, all other classes of these workers must meet three additional requirements as stated in Code Sec. 3121 (d) (3) before being classified as employees for FICA purposes: (1) they must personally and substantially perform all the services for remuneration; (2) they must not retain a substantial investment in the facilities to be used; and (3) they must continue the relationship on an ongoing basis. On the other hand an independent contractor is a person, business or corporation which provides goods or services to another entity under terms specified in a contract.

Unlike an employee, an independent contractor does not work regularly for an employer but works as and when required during which time, he or she may be subject to the Law of Agency. Contractors often work through a limited company which they themselves own, or may work through an umbrella company. If the one who pays for the labor and services of another has the right to control what will be done and how it will be done, this other person is an employee. This will be so even though the employee has been given some degree of freedom of action.

The key determinant is the existence of the right to control the details of how any work is done. Whether such control is actually exercised is irrelevant. If the one paying for the work does not have the right to control the day-to-day working but merely to direct the desired result, the person supplying the labour is an independent contractor. For example, if a builder uses the in-house employees for basic construction but hires in specialists for electrical, plumbing, plastering, and decorating work as and when required, these are likely to be independent contractors.

One clear sign will be whether such individuals are entered in the payroll system and paid as other employees, or paid when the work contracted for is completed and certified of satisfactory quality. Another major difference between an employee and an independent contractor is that an organization has to pay complete health benefits to its employee whereas to independent contractors there are no health benefits given which is also one of the main reasons why organizations these days prefer independent contractors more than employees because a burden on small business is the uncontrollable costs of employee health benefits.

The average total cost of health benefits for U. S. employees was $6,215 in 2003. To interpret Treas. Reg. 31. 3401(c)-1(b), the IRS issued Revenue Ruling 87-41, which lists 20 factors the IRS uses in determining the correct classification of a worker’s employment status. I am in this report mentioning some of the important factors that would clearly indicate the difference between employee and independent contractors. They are as follows: 1) If the person for whom the services are rendered has the right to instruct the worker how, when, and where to work, then the worker is ordinarily an employee.

This control factor is present if the employer retains the right to require compliance with the instructions, irrespective of whether the employer actually exerts the right to control. The instructions can be either oral or in the form of manuals and/or written procedures that state the details and means in which the result is to be achieved. In contrast, an independent contractor is responsible only for the end result. 2) An employer trains workers by requiring them to work with experienced employees, holding training meetings, corresponding with them, or any of several other methods.

By training a worker, the employer explicitly or implicitly states that the services to be rendered must be performed in a particular manner. The employer demonstrates a right to control by teaching the worker to achieve the desired results in that manner. Independent contractors, however, use their own methods and means to obtain a result and do not receive training from an employer. 3) If a worker’s services are integrated into the business operations, then the worker is generally subject to direction and control.

When the success or continuation of a business depends to an appreciable degree on the performance of certain services by a worker, those services are assumed to be subject to a certain amount of control by the employer. 4) The requirement that services must be rendered personally by the worker indicates that the employer is interested in the methods used to accomplish the work as well as in the result. Generally, inability to delegate the services to another individual indicates that the employer controls the details and means by which a result is to be achieved. ) If the employer hires, supervises, and pays a worker’s assistants, then the employer has control over those assistants and the worker should be considered an employee. However, if the worker hires, supervises, and pays his own assistants and provides the employer with materials and labor under a contract in which the worker is responsible only for the results, he is an independent contractor. 6) Continuous interaction between the worker and employer indicates an employee relationship. Such a relationship may exist in which work is performed at frequently recurring, though irregular, intervals. )

Establishing certain hours in which a worker is to perform a job indicates an employer’s control. The fact that an employer can dictate a worker’s hours is indicative of an employee relationship. 8) If a worker must devote full time to the employer’s business, the employer has control over the amount of time the individual actually spends working and, by implication, restricts the worker from performing other gainful work. In contrast, independent contractors are free to work when and for whom they choose. ) Workers required to perform their services on the employer’s premises when the work could be performed elsewhere are under the employer’s control, which is beyond that which would ordinarily be exerted over an independent contractor. The importance of this factor depends on the nature of the services involved and the extent to which an employer generally requires its employees to perform services on its premises. Control over the place of work is indicated when the employer compels the worker to travel a designated route, canvass a territory within a certain time, or work at a specific place. 0) If an employer has the right to indicate the order or sequence in which work is to be performed, then the worker is probably an employee, particularly if the same results can be achieved in a different order or sequence.

11) When a worker is paid by the hour, week, or month and such payment is guaranteed, whether or not certain results are achieved, the worker is generally an employee. In contrast, payments made by the job or on a straight commission basis generally indicate that the worker is an independent contractor. 2) The IRS is of the view that when an employer pays a worker’s business or traveling expenses, the worker is ordinarily an employee. Conversely, a worker who is paid on a job basis and must pay all incidental expenses is generally an independent contractor. 13) If the employer furnishes tools, materials, and other equipment for a job, this indicates that the worker is an employee. Independent contractors ordinarily furnish their own tools and materials. In determining what the classification should be, the value of the tools and materials supplied to the worker should be considered as well. 4) A significant investment by a worker in the facilities used in performing services for another is a factor that often establishes an independent contractor relationship.

Conversely, the lack of investment in facilities indicates a dependence on the employer for the facilities which means an employee relationship, exists. 15) A worker who stands the risk of suffering a financial loss or realizing financial gain as a result of providing services to the employer is generally an independent contractor. In contrast, a worker who has no risk of financial loss is usually an employee. 6) If a worker performs services for more than one unrelated person or firm at the same time, it generally indicates that the worker is an independent contractor. 17) Workers who make their services available to the general public on a regular and consistent basis are usually independent contractors. 18) Employers generally possess the right to discharge only employees.

The threat of dismissal demonstrates a degree of control over workers. In contrast, the IRS’s viewpoint is that independent contractors cannot be fired unless they violate the terms of the contract for services rendered. 9) If the worker providing the services can terminate the relationship with the employer at any time without incurring liability, an employee relationship usually exists. Conversely, an independent contractor engaged to accomplish a task or provide a service may incur a legal liability if the relationship is unilaterally terminated before the results of the task are accomplished. Employee versus Independent Contractor: Tax issue Due to the subjective nature of a worker’s employment status and the exorbitant costs of misclassification, Congress has attempted to provide a safe haven rule in Section 530 of the 1978 Revenue Act.

The Act was promulgated to protect employers who have consistently treated workers as independent contractors from the reclassification of their work force to employees. Although Sec. 530 has not been permanently codified in the Internal Revenue Code, it serves as a permanent relief provision under the current tax system. An employer is relieved of liability for back taxes, penalties, and interest when Sec. 530 is applicable. Sec. 530 allows workers to be treated as independent contractors only for federal employment and withholding tax purposes.

So a worker could be statutorily defined as an independent contractor under Sec. 530 but defined as an employee under common law in determining the status of a qualified pension, profit sharing, or stock bonus plan. The reclassification of a contractor to an employee could disqualify the employer’s pension plan and other employee benefits as a result of violating nondiscrimination requirements. Moreover, if a contractor is considered an employee under common law, business expenses for the worker would be deducted “above the line” and subject to the 2 percent floor rule.

Payments to an independent contractor that total $600 or more for the tax year must be reported by the business owner on Form 1099-MISC, “Miscellaneous Income,” and filed with the IRS. A copy also must be given to the independent contractor. When we talk about tax payments and employees the statuary law states that the employer must withhold federal income tax from your employee’s wages. To figure how much to withhold from each wage payment, use the employee’s Form W-4 and the methods described in Publication 15, Employer’s Tax Guide and Publication 15-A, Employer’s Supplemental Tax Guide.

Social security and Medicare taxes pay for benefits that workers and families receive under the Federal Insurance Contributions Act (FICA). Employers also withhold part of these taxes from employee’s wages and pay a matching amount. The federal unemployment tax is part of the federal and state program under the Federal Unemployment Tax Act (FUTA) that pays unemployment compensation to workers who lose their jobs. Employers report and pay FUTA tax separately from social security and Medicare taxes and withheld income tax. Employers pay FUTA tax only from their own funds for their employees.

Employees do not pay this tax or have it withheld from their pay. To encourage prompt payment of withheld income and employment taxes, including social security taxes, railroad retirement taxes, or collected excise taxes, Congress passed a law that provides for the TFRP. These taxes are called trust fund taxes because employer does actually hold the employee’s money in trust until they make a federal tax deposit in that amount. If an employer is forced to reclassify a worker from an independent contractor to an employee, the employer should attempt to mitigate the deficiency for back taxes, interest, and penalties.

The IRS does provide some statutory provisions that ease the employer’s increased tax liability due to a retroactive reclassification. The relief provided in Code Sec. 3509 reduces the amount of income tax withholding and the employee’s share of FICA taxes that would ordinarily be due. The amount assessable depends on whether the employer filed the worker’s Form 1099 on time. If so, the amount assessable is 1. 5 percent of the wages paid for income tax withholding and 20 percent of the employee’s share of FICA taxes.

If not, the amount increases to 3 percent of the wages paid for income tax withholding and 40 percent of the employee’s share of FICA taxes. Sec. 3509 does not reduce an employer’s liability for its portion of FICA and FUTA taxes. Nor does it operate to relieve an employer from any interest or penalties imposed as a result of misclassification. The IRS code cites several instances in which Sec. 3509 cannot be used by an employer. One is when the failure to treat the workers as employees was due to an “intentional disregard” of the applicable rules. A second is when the employer deducts income tax withholdings but does not deduct FICA taxes.

If the reclassification of a worker takes place according to Sec. 3121(d)(3), Sec. 3509 is rendered ineffective. Conclusion An employer should constantly evaluate the employment status of its workers to ascertain if any of them should be reclassified from an independent contractor to an employee. Misclassifying a worker could end up being quite costly in terms of time, money, and resources. If an employer is forced to reclassify independent contractors as employees, the payment of back taxes, penalties, and interest could create major financial problems. Ultimately, the risks of incorrect classification are borne by the employer.

Retention And Employee Turnover

Most organizations of today and probably of the future face critical labor shortages. Managers have to realize that the era of employer’s market or buyer’s market is no longer out there. The age of the Disposable Employee corresponding to the late 1980s and the mid 1990s has no remnant traces today. The new millennium has seen the emergence of the Indispensable Employee. The growth in economy surging ahead of the population growth resulted in labor shortages. The ‘skills gap’ or the gap in the expertise required for a task and that actually available in the workforce is also a cause of concern.

Managers increasingly need to understand what is required to manage the present day workforce, given the changing relationship between employer and employee. To effectively manage today’s workforce, they must determine and analyze factors including whether the labor shortage is going to be a permanent one; how to recruit and retain a diverse workforce and the way the workforce has changed. Several progressive companies are increasingly under pressure for not being able to grow despite having the required financial resources. This is because of their inability to rope in the appropriate people.

Several businesses have cut their working hours due to insufficient staffing. When organizations don’t have sufficient staff, their customer service quality declines. This is mainly because the ones who are available are overworked due to inadequate staffing, resulting in them being less hospitable to the customers. Today’s managers face an uphill task of recruiting and retaining competent staff and are increasingly acknowledging, that the best form of recruitment is retention. It is therefore a little know secret that all organizations indeed lose good people either due to attrition, lay off or retirement.

Organizations must acknowledge the fact that someday even their most valued employees would leave. The retention strategies of human resource management are aimed at ensuring that key people remain with the organization. These strategies are based on the understanding of why people remain with the organization and why people leave it. Attitude surveys would establish reasons as to why people remain in the organization. Exit interviews may provide information as to why people leave to organization, but such interviews are unreliable, as people rarely give full reasons for leaving.

Retention plans are directed to address all areas were lack of commitment by employees or employee discontent can crop up (Armstrong, 2003). Employee turnover may be described as the transit of people into and out of active employment. Turnover costs include both, the costs associated with the person leaving and those associated with the new recruit. Organizations analyze employee turnover based on employee demographic profile which are developed using individual’s details like age, sex, race and place of stay etc..

Analyzing turnover based on this employee demographic profile would project a lot of useful information on why staff leave or staff stay (Fields, 2004). Recruitment and retention strategies can be improved using such analysis. Turnover must be dealt from within the organization. Employees who are dissatisfied and plan to leave may cost a lot to the organization. Low employee morale is infectious and would lead to low productivity, employee theft or sabotage and unwillingness to recommend the organization to prospective employees and customers. Retention and Employee Turnover 3

One of the important factors for employee discontent and a major cause for employees leaving the organization is the pay. Unfair pay systems and uncompetitive pay cause employees to look for alternative employment. Organizations must recognize pay structure and pay system as important to retention strategy and ensure that is it attractive and friendly. The pay levels must be reviewed regularly on the basis of market surveys. Job evaluation must be introduced and employees should understand the logic of performance and reward. The involvement of employees in the development and implementation of job evaluation schemes is very crucial.

This would give transparency and confidence to the employee on the functioning of the job evaluation scheme. The pay and benefits needs to be tailored to individual requirements and preferences, such that it is suitable to every one. Each job must be designed to provide opportunities for learning and growth. The jobs must be able to enhance skill variety, incorporate task significance and also include autonomy and feedback. Job dissatisfaction is an obvious outcome caused by jobs that are seemingly unrewarding in themselves. Employee resignations and turnover is also increased when people are not trained properly.

Employees begin to feel that the demands made on them cannot be fully delivered without proper training. When new employees are not provided adequate training, they experience an ‘induction crises’. Learning and training programs raise existing skills and competences among employees to expected standards, while increasing their morale and confidence. Employees must be encouraged to acquire new skills so that they can assume bigger responsibilities and perform various tasks. Such multi-tasking would also help them to earn more under skill-competency based pay structure.

Demotivation of employees takes place when performance standards and assessments seem unfair. Employees must be aware of the responsibilities and performance standards expected of them. Performance expectations may be set to be hard, but should however be practically achievable. Setting of goals and ways of achieving the same must be discussed and agreed upon by the employees and the managers. Managers need to praise employees for good performances while at the same time discuss performance problems as and when it happens, so that corrective steps can be taken immediately.

It is important that employees are aware of how the performance management system works. Low career prospects have been studied to be among the major causes of turnover. Organizations need to provide a wide opportunity for the career development of all its employees.. Individuals who acquire several skills tend to change career direction, several times in the course of their career. People increasingly conceive that a career development is associated with moving onto another organization.

To maintain a stable workforce, employers must identify potential using better systematic procedures and encourage promotion internally. Career opportunities can be provided by encouraging employees to gain a wide experience and advising them on their career paths. Retention and Employee Turnover 4 Conflict and dissatisfaction with superiors like supervisors and mangers is another common cause for resignations (Armstrong, 2003). When managers or team leaders fail to provide the required leadership by bullying their staff or treating people unfairly, it gives rise to employee discontent.

Such situations emphasize on the qualities of the manager and the team leader. Only those with well-developed leadership qualities must be selected as managers and team leaders. They should be trained in leadership skills, methods of resolving conflict and also on dealing with grievances. Poor selection or promotion decisions too can result in rapid turnover. The selection and promotion processes must be on par with the capabilities of the individuals, with regard to the work they do. Holding on to their employees require a strategy and organizations take several steps to ensure this.

Inc magazine once reported in its January 1998 issue that a company RHS Help Desk, based in New York had cut its turnover from 300 percent to 25 percent just by redesigning its employee orientation program, implementing a career ladder and communicating at least on a weekly basis with its field staff. Companies occasionally take to short-term efforts like UPS which once promised its employees a bonus of $1300 on the condition they stay till the end of the year, which ensured that the employees were there to meet the holiday rush. It should be noted here that turnover is not always negative.

Sometimes turnover might be required too. The important fact however is in realizing when an organization needs a turnover, and managing the situation effectively. The employee resources strategy of any organization ensures that people required by the organization are obtained and retained in the employment of the organization. The employee resourcing strategy is a vital aspect of the Human Resource Management (HRM) process. The primary aim of this strategy is that the organizations employ more competent people than its competitors.

Such people, with their wider skills and knowledge would provide an increased contribution to the growth of the organization. An organization can attract such people by being a ‘preferred employer’. It then needs to retain them by providing opportunities and rewards, which are much better than others. It is also very important for the organization to develop a positive psychological contract with the employee to create a mutual trust and increase commitment. The psychological contract is a set of unwritten and mutual expectations and obligations between each employee and the employer.

The psychological contract is directed to answer basic employment questions like ‘What can I reasonably expect from the organization? ’ and ‘What should I be reasonably expected to contribute in return? ’. The psychological contract develops overtime, allowing employees to reevaluate their expectations with changing employment conditions while gaining experience. From the employee’s point of view, psychological contract would be based on trust in the management to keep its promises, security of employment, career expectations and opportunity to show competence.

For the employer, psychological contract would Retention and Employee Turnover 5 emphasize commitment, competence, effort, compliance and loyalty. A psychological contract is required for maintaining a harmonious relationship between the organization and the employee. However, violation of this psychological contract can imply that the organization and employee no longer share, or perhaps never had a common set of values or goals (Sims, 1994). Retention steps are often intermingled with recruitment efforts, although many see both as two different aspects.

Organizations would fail miserably despite having detailed, planned recruitment programs, when the hired individuals find the environment inhospitable and look for alternatives in the recruitment market. News of ill treatment by employers and employee struggle stories are propagated much faster than good treatment and good employers. Organizations have plenty of scope and opportunities to improve their efforts towards retaining employees. Research into retention identify certain crucial aspects of employment contributing to it.

The presence of an inspirational leader with a vision for the organization contributes to employee retention. Such leaders spread the organization’s ideas through their own words and actions. When the organization’s or leader’s vision is clear to employees who identify with it, they too want to be part of the winning team, whenever it achieves the goal. Workers here know the progress and direction the company is making, and also of their contribution to its progress. Communication is crucial to all retention efforts. In the absence of proper communications, rumors would be doing its own rounds.

Staff ideas and opinions should be encouraged and two-way communication maintained between executives and workers, through managers and supervisors. Retention efforts need to be evaluated to understand its effectiveness and its shortcomings. The success of such efforts can be judged from exit interviews, turnover statistics and inputs from suggestion boxes, employee open forums, surveys/questionnaires and through staff meetings. Organizations strive to enhance retention of their employees in several ways. Managers must be aware of the tight labor market and its relevance on their retention efforts.

Employees need to be regularly surveyed to know what they want and the benefits provided to them should be in line with their requirements. Guessing what the employees would want would be a mistake. Studies show that though employees might not have actively pursued the idea of leaving the organization, the thought of leaving would have certainly been explored. Such employees who are not-completely satisfied serve as the main targets of employers poaching for labor. Pricewaterhouse Coopers had surveyed several investment management employees for its 2000 Report on Recruiting, Retention and other Employment Practices.

The results showed that all surveyed people believed that they could earn more somewhere else. Everyone also believed that in case they left the organization, it would be difficult to find a replacement and would also cost the company more to hire a replacement. Retention and Employee Turnover 6 Commitment by an employee is the level and intensity of an individual’s identity and involvement in an organization. Commitment reflects an individuals desire to remain with the organization, his belief in the values and vision of the organization and willingness to contribute more to the organization (Porter).

However some argue that commitment by employees to unilateral values and goals would not help them to handle any ambiguities or unexpectedness, which an organization is prone to. In deciding to commit to an organization, it was learnt that people attached importance to certain factors. Learning opportunities, competitive compensation and opportunities for career enhancement are among the main decisive factors for employees committing to an organization. The work environment, employee benefits and the firm’s reputation are the other important factors for an employee committing to an organization.

When problems associated with an organization’s turnover is to be resolved, it is primarily necessary to study the underlying causes (IDS, 2006). The attrition level must be viewed against those prevailing in similar organizations. Certain issues can be resolved at a primary level by just responding to employees concerns or ideas and bringing in appropriate changes. However in general, retention complexities would require broader adjustments through long-term plans. Organizations introduce several initiatives not only to tackle retention but also to be seen as a ‘great place to work’ or an ‘employer of choice’.

Employee Rewards – Important Role In The Motivation

Employee rewards play a very important role in the motivation of employees in any given organization. Introduction Business organizations rely on many resources such as; human resources, technology as well as raw materials to achieve organizational goals and get things done. However, of all resources an organization has access to it is the human resources that are important as well as very difficult to manage. This is a clear indication that human resources constitute of a central and very important component of organization.

Human resources are complex and they are equally complicated to manage considering the fact that some organizations could have upto thousands of employees. This is an indication that management of such employees requires expertise as well as deep knowledge of principles of human resource management. Despite the size of an organization it is the human resources that keep the organization moving. Hence the role of motivation in getting employees to perform. Motivation is the process of empowering an individual to continue acting in a certain positive behaviour .

Motivation in an organization is aimed at encouraging workers to take initiative in the execution of their duties, to align their goals to that of the organization, to function in teams as well as to achieve royalty to the organization . Motivated employees demonstrate the willingness to work for the organization through innovativeness, self-drive as well as a willing desire to perform their tasks in accordance to the organization’s objectives. Maslow’s theory maintains that employees behaviour is influenced by wants and desires which unless satisfied and fulfilled, they continue to determine and influence how an employee behaves .

In an organization employees have expectations for the reasons they work. Some work solely for money, others work because they love that kind of job, while others come to work simply because they consider the workplace as a social place where they get an opportunity to meet friends. This is a clear indication that it is important for human resource managers to understand the dynamics of employee motivation so as not to mistakably overuse any one given kind of reward .

Organizations have different ways of rewarding their human resources. The most notable rewards used by most organizations are pay hikes as well as salary increments. Although this is one of the most common forms of rewards it has been found to be largely ineffective in improving employee performance . This can be attributed to the fact that in the past human resource managers failed to appreciate the fact that different people work for different reasons and not everyone is motivated to work purposely for money .

As a result, some organizations have shifted from pay-based rewards to other forms of rewards such as promotions, increased responsibilities for example training and career growth opportunities. Another common form of rewards organizations are using is performance based pay, which links output to income . Under performance based pay employees are paid per the amount of units they produce and as a result management uses the system to encourage employees to work more since working more translates to earning more.

However, it should be noted that this kind of reward works better for wage payments under schemes such as casual labour schemes . In conclusion, employee motivation is a dynamic concept and it is simply not true that the same solution works in all situations in as far as human motivation is concerned. It is clear from the discussion above that different people have different reasons as to why they work and therefore using the same kind of reward every time such as pay increase may fail. The solution lies in the combination of more than one type of rewards to motivate staff so as to take care of the different needs amongst employees.

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