Freelancers, employees, and independent contractors can all do the same things. A tax accountant, for example, prepares tax returns, balances books, and maintains financial ledgers. A freelance accountant, on the other hand, is not the same as an employed accountant.
While it may seem a simple issue of semantics, job classification is a critical component of any job arrangement. When looking for work, not knowing the distinctions between a freelancer, independent contractor, and employee can have a significant influence on your taxes, benefits, and compensation.
Job classification matters a great deal
While most people are aware of the distinction between employee and freelancer, it’s a crucial distinction that can be hazy at times. While the terms freelancer and independent contractor are used interchangeably, they’re not one and the same.
Though there are various ways to characterize your professional self (solopreneur, sole proprietor, freelancer), the only ones that matter are those that the IRS acknowledges.
According to the IRS, your employment status is determined by your relationship with your employer. Legally speaking, while it’s your employer’s responsibility to categorize you correctly, understanding how the IRS defines these classifications is of great significance. It’s also critical that you comprehend your employer’s classification system.
When it comes to taxes, the IRS puts freelancers and independent contractors in the same category, i.e., independent contractors. However, several key distinctions are to be made between workers and independent contractors (freelancers).
Independent Contractor vs. Employee
The IRS looks at three factors in any job arrangement to decide whether you’re an employee or an independent contractor. These are the ones:
- Behavioral control: who decides when, where, and how you work?
- Financial control: who’s in charge of your job’s financial and business aspects?
- Relationship control: does the employer offer benefits, and does the job have an end date?
So, what does all of this mean?
As per the IRS, you’re an employee if:
- Your employer determines when, where, and how you work. For example, your boss tells you that you must be at the office every day (or online) during normal business hours, gives you a laptop to use, and tells you how to do your job.
- Your employer determines how much you’re paid, how much of a raise or bonus you receive, and how much you’re reimbursed for work-related expenses.
- Your employer offers you perks (such as retirement and health insurance) and expects you to stay with the company until you quit or are fired.
- In contrast, an independent contractor has a completely different relationship with their employer. You’re an independent contractor if:
- You have complete control over when, where, and how you work (with some exceptions).
- You choose who you want to work with and establish your own pricing.
- You don’t get any benefits, and your contract has an end date (meaning, when the project is complete, you’re no longer working for the employer).
Of course, this only touches the surface of employee classification, but it does illustrate several key distinctions between employers and independent contractors. And you’re not alone if you find this confusing. For years, several states have struggled with the ambiguity of these definitions and norms. Some states have even attempted to define employee vs. contractor status through legislation with varying degrees of success.
Freelancer vs. Independent Contractor
While the IRS classifies freelancers and independent contractors as one category for tax reasons, there is a significant difference between the two employment classifications (though it’s not tax-related).
According to the IRS, an independent contractor is someone who works “in an independent trade, company, or profession in which they offer their services to the general public.”
What does this imply?
The IRS has listed some examples of independent contractors. Doctors, dentists, lawyers, and auctioneers, for example, are all included, as are temporary employees.
Most independent contractors work for only one employer at a time. However, they may work with a few clients at a time. The tasks that the independent contractor accepts are typically big and long-term. A contractor, for example, might take on your home remodeling job. However, your project is only one of three that person is working on, and when it’s finished in six or nine months, the contractor moves on to the next one.
On the other hand, freelancers work for as many clients as they can handle at any given time. Typically, the projects they work on are modest or have short timelines. A freelancer may work for one client and then proceed to another or several others. That said, freelance arrangements might be ongoing.
Who is responsible for what?
Employees, freelancers, and independent contractors all have these “significant” differences. However, before accepting a job offer, you should be informed of numerous crucial characteristics of the various employment statuses and work categories.
Taxes
Employee
Employers handle all aspects of an employee’s taxes, including withholding the exact amounts of taxes owed before issuing paychecks and paying the necessary amount to the IRS on the employee’s behalf.
Contractors and Freelancers
Self-employed people must pay their own income tax and self-employment tax. That doesn’t just imply writing a cheque every year on April 15th. Freelancers must also pay anticipated quarterly taxes based on their expected earnings. Fines and penalties may be imposed if this is not done. The tax write-offs, such as a home office deduction and other relevant business expenses, are one advantage of filing as an independent contractor.
Benefits
Employee
Employee benefits such as retirement programs and paid time off are common in most jobs. Your business may be compelled to provide health insurance, unpaid leave, or even paid leave to employees in specific instances. Many employers even go above and beyond by providing life, disability, and even pet insurance. While you may be responsible for some of your benefits (such as health insurance), your employer is likely to cover a portion of the costs.
Contractors and Freelancers
Contractors and freelancers are responsible for their own medical and retirement insurance. They don’t get paid time off for vacation, maternity leave, holidays, or sick days. As a result, freelancers act as their own HR department. They must become proficient in financial planning and time management and fund all of these perks without the assistance of their employer.
Unemployment and Workers’ Compensation
Employee
When you work for someone, your employer is obligated to carry worker’s compensation insurance and pay state unemployment taxes. You may be entitled to monetary compensation from the state if you are injured on the job or if you are laid off.
Contractors and Freelancers
You’re out of luck if you get hurt on the job or if your boss decides to fire you one day. You have no right to get benefits from the unemployment office.
Seeking More Work
Employee
Employees may still expect to be paid if they show up (or log in) regardless of their performance. Employees will always have a job unless they’re told differently. They’re normally given plenty of notice before being laid off, and they may be eligible for job placement assistance or severance pay.
Contractors and Freelancers
Because freelancers’ livelihood depends on maintaining a consistent stream of money, they must consider future assignments while performing current tasks. Suppose a freelancer is unable to balance working on current tasks while still looking for new work. In that case, they may find themselves without any more work lined up. Freelancers have short-term objectives such as completing an assignment, receiving payment, and moving on to the next project. There are certain exceptions, but working as a freelancer necessitates a delicate balancing act of focusing on present jobs while keeping an eye on the future.
Flexibility and schedules
Employee
While flexible and remote work is becoming more popular, most employees don’t have much—if any—control over their schedule. For example, if the job requires a 9-5 presence, then that’s when you’re expected to work.
Contractors and Freelancers
Employees often envy freelancers’ ability to work on their own schedules. You practically have complete control over your schedule as a freelancer.
Money matters
Employees
Generally speaking, employees don’t get much say in their pay, raises, or bonuses. While you may receive a higher bonus if you perform better or meet certain objectives, the final decision is made by your employer, who sets the bonus schedule.
Contractors and Freelancers
Contractors and freelancers can set their own fees. They have the option to charge more or accept less. However, it doesn’t mean everyone will accept them.
Payday
Employee
Not paying employees is against the law. In the unlikely event that you didn’t receive your paycheck from your employer, you could reach out to your state’s labor department, which will help you recover your unpaid wages.
Contractors and Freelancers
If a client fails to pay, you may be out of luck unless you file a lawsuit. Even if you have a good contract, there is no guarantee that you will be paid.
Feedback
Employee
As an employee, you should receive regular feedback on your performance. Even if you don’t get regular feedback, you’ll almost certainly get an annual review. While your company isn’t obligated by law to conduct an assessment, most companies will do so to help you grow.
Contractors and Freelancers
Freelancers and contractors, in general, will not receive feedback, let alone a formal review. While you and your boss may talk about how the project is doing, they won’t provide any constructive criticism to help you learn or grow. It’s assumed that you already know what you’re doing and don’t require any training.
Who you work for
Employee
As an employee, your options are limited. You’re an employee of the corporation that hires you.
Contractors and Freelancers
You’re in charge of your own destiny. However, there may be clients or firms with whom you don’t have a solid working relationship. Whatever the case may be, you always have the option of terminating your employment relationship with them and leaving. But keep in mind that you’re in command of those procedures.
Understanding your job classification
Your working relationship has an impact on how you pay taxes (and how much you pay), whether you have certain rights, and even if you can protect your paycheck. While understanding the differences is crucial, make sure you’re clear on your employment status before accepting any job offers.
We’ve got all kinds of tips to help you figure out what kind of employment relationship you’re searching for. Read these tips to learn how to locate a job opportunity and what it takes to be a successful freelancer.
