What's the difference between an employee and an independent contractor?

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The distinctions between employees and contractors can be confusing, but it’s important to correctly classify the workers you pay. Both positions have different tax obligations for your business.

The primary difference between an employee and a contractor is the degree of control you have over how the worker does their work. The IRS categorizes these distinctions as behavioral, financial, and relationship.

An employee:

  • Reports to you, or to someone else who works for you. You or your business control when, where and how the employee’s work is done, and measures their performance
  • Uses your business’s resources and materials to do their work
  • Is paid a regular wage, with income tax and other statutory deductions withheld
  • Has the expectation of an indefinite relationship with you, with no fixed term of employment
  • Receives a W2 at the end of the year

A contractor:

  • Has individual control of when, where, and how they perform their work. Your business has input on the final product, but the contractor controls the process
  • Uses their own resources and materials to do their work
  • Is generally paid a flat fee for a project, and is subject to self-employment tax
  • Works on a fixed contract or term, with an intended end date
  • Receives a 1099-MISC form at the end of the year

Incorrectly classifying a worker who is an employee as a contractor will have serious tax implications for your business. If you misclassify an employee as a contractor, that means you aren’t paying federal employment tax, as well as other statutory deductions like Medicaid and Social Security. Your worker is also not covered by unemployment insurance and worker’s compensation.

To protect your business, it’s important to evaluate your relationship with your workers according to federal law, and treat them accordingly. Failure to do so could result in financial penalties including requirements to pay back wages and taxes.

While the IRS notes that there is no “magic formula” for determining the status of a worker, consider whether you have an ongoing relationship with a worker, pay them regularly, and/or if they work out of your business location or use your materials or resources. These elements indicate that a worker should be classified as an employee.

If you’re still unsure, the IRS can help you classify your workers using Form SS-8.