One of the biggest decisions you will need to make as a business owner will be whether to hire employees or use the services of subcontractors. There are major differences between both statuses and they will also affect your bookkeeping and tax liabilities. There are some businesses that use one or the other and there are even some businesses who use both types of workers. Before making your decision, it is important to understand the differences between an employee and a subcontractor.
Definition Of An Employee:
According to the IRS, there are three fundamental criteria to determine if a worker is an employee. The first is how the work is performed. If the employer determines how or the manner in which the work is performed, they are probably an employee. The second is the financial criteria and looks at who has control over the financial resources used in performing a job. If the worker is compensated directly for driving their own car, this is considered an employee function. Finally, if the worker is given perks like health insurance and an understanding of a certain number of hours of regular work, chances are there is an employer-employee relationship.
Definition Of A Subcontractor:
The definition of a subcontractor is not nearly as clear-cut. However, the basic operating principle seems to center around the idea of control. If a worker is more or less autonomous in how they perform work, they are generally going to be considered as a subcontractor. In other words, if you tell the worker what you need accomplished, they are likely a subcontractor. If you tell them to go somewhere and do X,Y, and Z they are almost certainly an employee.
Although understanding both basic definitions is a great place to start, there are additional considerations. It should be obvious, but if a worker is receiving a steady paycheck they are most likely an employee. On the other hand, if a worker provides their own tools and/or equipment or if they control the hours of their employment, chances are good they are a subcontractor. You can also look at the work itself to help differentiate between these two types of workers. If the work is integral to the business, the worker performing it will most likely be an employee. Temporary and non-integral work is more likely to be performed by subcontractors.
Basically, the employment status of the workers in your business will determine your tax liability. For employees, you will need to pay federal and state unemployment taxes, social security and workers compensation premiums, etc… If the worker is classified as a subcontractor, you do not need to pay any of these taxes. The subcontractor is entirely responsible for paying their own taxes.
The main difference between whether a worker is treated as an employee or a subcontractor comes down to how much (and who has) control over that work. If you are directing and instructing the work not only what to perform, but how and even when to perform the work they are probably going to be considered as employees. If the worker is free to determine (more or less) when and how to do the work, they are probably a subcontractor. Knowing this difference can help you better decide how to structure your work and when to use each type of worker.