This distinction between the two is especially important with respect to how income earned by an employee or independent contractor is handled for tax purposes, in addition to whether laws governing the relationship between an employer and an employee will apply.

Employees' paychecks are subject to the withholding of personal income tax (both federal and state). An employer has one-half of the Social Security tax and the Medicare tax deducted from the employee's wages, and the employer contributes the other half. An employer makes contributions to the federal (and sometimes state) unemployment insurance system, various state employment systems (such as disability or education and training), and provides worker's compensation for the employee in case of an accident which occurs during the course of employment. These benefits are big plusses for employees; however, this "loading" for taxes and benefits can represent a cost to an employer of an additional 20% to 35% over and above an employee's gross wages.

An independent contractor is in business for him/herself and generally has more control over hours and schedule. The independent contractor makes quarterly federal and state personal income tax deposits (based on yearly estimates), pays the entire contribution to Social security and Medicare taxes, and provides his/her own insurance and benefits. An independent contractor is not subject to wage and hour regulations and does not benefit from any unemployment insurance program.

Click here for an informative article on company policies regarding employees and contractor.

(Reviewed 9-08)