Employee Vs Independent Contractor

Note: This article was written prior to the enactment of the AB-5 bill in California. In addition to the information contained below, I encourage you to read this article on Castifi’s blog.

If someone has ever given you the option to chose between submitting an invoice or filling a time card, and you didn’t know which one was better, this article is for you!

Disclaimer: I am not a Certified Public Accountant. The information below was gathered from personal and work experience, but should not be used to make any financial decisions.

 The main differences between Employee and Independent contractor

When you submit an invoice, you are what’s called an “independent contractor”.
When you fill a time card, you usually are an “employee”.

Taxes

Independent contractors receive the “gross” amount for the job and pay taxes on a yearly basis. They can offset that with tax deductions.

Employees pays taxes at the same time that they get paid (they receive the “net” amount for the job). Taxable income is withheld from their check.

Protection

Independent contractors don’t get covered by the company who hires them.

Employees are usually under their employer’s worker’s compensation insurance, which covers them in the event of injuries at work.

Benefits

Independent contractors don’t receive any.

Employees, as mentioned above, pay into the various state and federal social programs such as Medicare or the FICA (Federal Insurance Contributions Act). Their employer also contribute to these programs for them.
Full time employees are usually offered some sort of insurance package, a retirement plan (401K) and sometimes, equity in the company.
But freelancers are usually treated as employees without all these benefits. Most payroll companies (which pay employees on behalf of the employer) have a medical insurance program which allows the employee to pay a monthly premium in exchange for health insurance.

What should you be?

If the IRS didn’t exist, this entire discussion wouldn’t be very important. But, taxes are taxes, so let’s take a look at how the IRS describes each status:

IRS’ definition of an employee:
“Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.”

IRS’ definition of an Independent contractor:
“The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”

Based on this, it would seem that every freelancer should be an employee. But there are some factors that could make you an independent contractor:

• You work in a creative position and are a decision maker (Producer, Director…)
• You provide an all inclusive service besides manual labor (location, equipment…)
• You deliver a product, such as a script or video. In this case, you and your employer could argue that you are selling the rights to material, and not the time that it took you to make it.

The Pros and Cons

Being an employee gives you the peace of mind that you won’t run out of money at the end of the year. Of course, it’s annoying that you don’t get paid as much on the spot, but it’s very common for independent contractors to spend all their money and become in debt to the IRS when the end of the year comes. By the way, the IRS is allowed and able to garnish your wages, so there is very little chances to escape that debt.

Being an employee also protects you from unscrupulous employers. The person hiring you will have to play by the State’s rules when it comes to overtime, meal penalties, and protection. If you get injured on the job, it’s a lot better to be covered by your employer’s insurance than to go out of pocket.

As an employee, you will receive a W2 for each of your employers. All you need to do for tax purposes is sending that document. As an independent contractor, preparing your taxes is a lot more complex, but, with a good CPA, can spare you a lot of taxes.

As mentioned earlier, payroll companies usually offer a health insurance package. Most of them require that you work a set number of hours within a month, and then maintain a certain quantity of work. The insurance provided isn’t great, but usually better than the ACA (Affordable Care Act, AKA “Obamacare”) or private packages. The huge downside is that you must keep working for companies that use the same payroll company. If you get your hours with Payroll Company A, then go work on a different project that uses Payroll Company B, you’ll have to start from scratch.

 Can you get into trouble for working as an independent contractor?

Yes. You and your employer can get into some trouble, resulting in back taxes and/or fines. It is a known fact that the IRS is not a fan of the independent contractor loophole. Many payroll companies which used to allow sole proprietors to be paid as “loaned out employee” (more on this in a future article) no longer do because of the IRS’ stance on the subject.

But don’t panic quite yet. Most people are too small a fish for the IRS to pay attention.

The main way that the IRS has to spot irregularities is to notice large sums of money being exchanged between 2 parties. Let’s say that you freelance for one company exclusively. When filing your taxes, the IRS might notice that 100% of your income comes from the same employer, which will trigger some questions. After all, if you only work for one company, shouldn’t you be their employee? But if your annual income is under $100,000 it’s pretty likely that your taxable income is minimal as well, and hence, not worth the hassle to audit you.

Tips and Tricks

If you are a writer or director, expecting a delivery fee for a project:

Ask for the fee to be “spread out” over several tax weeks. For instance, instead of one time card for $20,000 ask for 10 time cards for $2,000.
What’s the difference? Well, the taxable income for each check is calculated based on the amount of money you make in a week. The payroll company looks at that amount, multiplies it by 52 (weeks), and picks the right tax bracket rate based on this.
So with a $20,000 check, your tax bracket rate will be the highest it can be (39.6%).
With a $2,000 check, your tax bracket rate will be around 25%.
It’s worth noting that if you pay too much taxes, the IRS will pay you back at the end of the year. But most people would rather get that money directly from their employer!
Finally, these time cards can be created retroactively. For instance, if you start a project on January 1st, and deliver it on March 1st, you can ask the employer to divide the total fee by 9 weeks. You will receive 9 checks at once.

If you are in a position where you bring equipment:

The equipment you bring to set can be paid for separately. Rather than a $250 day rate, ask for a $200 day rate, and a $50 box rental.
The box rental is the fee for your equipment, and is NOT taxable (the IRS considers that you have already paid taxes when you bought it).
Caution: Do not go crazy by asking to be paid minimum wage and a huge box rental. This is a loophole that the IRS is very well aware of, and will increase your risks of being audited. A director of photography making $168/12h but receiving a $1,000 daily box rental is very suspicious.
Overtime note: Remember that the lower your day rate, the lower your hourly rate becomes. If you decide to offset your taxable income by using a box rental, you will also lose money if you go into overtime. A $250 day rate gives you $35.71/h in overtime (in California) whereas a $200 day rate + $50 box rental gives you a $28.57/h rate in overtime.

If you are an actor:

As an actor, you provide 2 services: You physically act on set, and you usually contribute to the project’s marketing by making appearances or posting on social media.
Because of that, it is possible to split your payment into 2 parts:
The fee to be on set. For this, you are considered an employee. It should be minimal but not too low. You can use the union scale, or look at the average non union rates.
The fee to market the movie. For this, you are considered an independent contractor. It’s easy to argue that you are paid for your existing social media presence.
In the end, you end up with all the advantages of both systems.

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