Payroll for Independent Contractor vs Employee: What’s the Difference?

Whether you’re on the giving or receiving end of payroll, understanding the differences between employees and independent contractors is crucial. No one wants a fine from the IRS because they filled out the wrong tax form, or an unexpected budget hit when taxes owed are double the amount they budgeted for. Plus, misclassifying workers can result in penalties and legal action.

Investing in good payroll software can prevent these shortcomings and automate your processes, saving you time and money.

In our short, actionable guide we explore the key payroll differences between independent contractors vs employees in terms of taxes, benefits and contributions, and payment schedules.

Key Takeaways

  • Running payroll is more complicated for employees than it is for independent contractors because of tax withholdings, employer benefits, and misaligned pay periods.
  • Employee payroll taxes are calculated by the employer and reflected in payroll. Independent contractor taxes are ignored by the client and paid by the contractor.
  • Employees are entitled to benefits from their employers, which complicates payroll calculations. Independent contractors are usually not entitled to any benefits.
  • Employees are paid regularly under strict regulations, resulting in year-end payroll adjustments or extra math. Independent contractors are paid on a per-project basis, with pay frequency determined by the contract.

Tax Withholding and Reporting

Employee

Employees have minimal tax responsibilities, making payroll a time-consuming process for the employer.

At the beginning of employment, employees fill out form W-4, which details their basic withholding preferences. Employers are then required by law to withhold income taxes, Social Security taxes, and Medicare taxes from their employees’ payroll. Additionally, employers must pay the “employer share” of Social Security and Medicare taxes, which are 6.2% and 1.45%, respectively.

Employers also report their employees’ earnings to the IRS through form W-2, which shows total money earned and taxes withheld for each employee. Employees are then simply responsible for double-checking the amount on the W-2 and contacting the IRS for a tax refund or bill.

Independent Contractor

Independent contractors receive full earnings on their payroll, eliminating tax calculations for the client.

Clients who hire contractors don’t withhold their wages—they pay the full amount directly to the contractor. It then becomes the contractor’s responsibility to calculate and pay income, Social Security, and Medicare taxes. And since contractors are considered self-employed, they must pay the employee and employer shares of Social Security and Medicare taxes—totaling 12.4% and 2.9%, respectively.

All the client has to do is report contractor payments exceeding $600 to the IRS, once per year via form 1099-NEC.

Contributions and Benefits

Employee

Employees receive numerous benefits from employers, which need to be reflected in their payroll.

Employers are responsible for contributing to state and federal unemployment tax acts on behalf of their employees. They’re also required to provide workers’ compensation insurance for some employees in the case of workplace incidents.

On a more optional basis, employers generally reimburse their employees for any work-related expenses, and may even offer retirement plans or discounted health insurance.

Independent Contractor

Independent contractors generally don’t receive any benefits, streamlining the payroll process.

Employers aren’t required to pay unemployment taxes, workers’ compensation premiums, or contribute to retirement or health insurance.

If contractors incur business-related expenses on behalf of their clients, it’s usually not reimbursed unless specified in the initial contract.

Payment Schedule and Regulation

Employee

Employees are usually paid on a recurring schedule with certain regulatory standards, resulting in extra payroll calculations or year-end adjustments.

Most employees are paid on a bi-weekly basis, though weekly, semi-monthly, or monthly payments are common as well. Employees are paid on this regular basis, regardless of how much or how little work they do in a given period.

Additionally, employees are usually entitled to a certain minimum wage (which varies by state), as well as time-and-a-half pay if they exceed 40 hours of work per week.

Independent Contractor

Independent contractors are usually paid on a per-project basis and with less regulation, resulting in simpler payroll that can be run less frequently.

Most independent contractors are hired because there’s a specific project the client needs to have completed. Because of this, they’re usually paid when they finish the project, or on an infrequent basis throughout the duration.

Minimum wage requirements and overtime pay don’t apply to independent contractors. The client usually isn’t even keeping track of how many hours their contractors work. Instead, it’s up to the contractor to work as much or as little as necessary to complete the project for the client.

Conclusion

Employees don’t calculate their own taxes, they receive contributions and benefits from their employers, and they’re paid on a regular basis under hefty regulations. This makes their payroll taxes complicated and time-consuming for the employer.

Independent contractors calculate and pay their own taxes, don’t receive contributions or benefits, and get paid on a per-project basis with minimal regulation, which makes their payroll taxes generally more straightforward.

If you’re getting ready to send out your first payment, check out our guide on how to run payroll yourself.

FAQs

How does an independent contractor differ from an employee?

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Robbie Mizzone
Editor

Robbie holds a BSc in Accounting and Finance from Centenary University, New Jersey. He's worked for banks and private companies alike, including Kering (Gucci, Balenciaga), focusing on financial reporting, account reconciliation, and complex accrual analysis. An avid explorer and jack of all trades, Robbie's garnered experience in luxury hospitality, carpentry and construction, and is now backpacking solo around the world.