When you make the move from being an employee to a freelancer or business owner, a lot changes. If you are used to the employee/employer relationship, it can be difficult to change your mindset and your actions into that of an entrepreneur. It is absolutely vital to recognize these changes, however, in order to take full advantage of your independent status and avoid some of the common pitfalls.
Here are some of the biggest differences between being an employee and working for yourself.
When You Are Self-Employed…
- You determine what work you do and when you do it.
- You advertise to and accept work from more than one client.
- You may operate your business under a specific business name.
- You do not get employee benefits from your clients (i.e. a pension plan, insurance, vacation pay, etc.).
- You are responsible for paying your own income taxes.
- Your clients typically do not provide training or extensive instruction on how to do your job.
- You normally supply and maintain all of the equipment necessary to do the job.
- You may have employees or subcontractors of your own.
- You are not subject to an employee evaluation process.
- You alone control the opportunity for profit or loss from your work.
- You have a contract that outlines the terms of your working relationships.
- Your contracts tend to be for a specific project or time period.
- You invoice your clients for work completed.
Distinguishing Between an Employee and Independent Contractor
In the U.S., the IRS tends to consider all workers employees, so it’s very important to position yourself as an independent worker from the beginning. When the IRS analyzes working relationships, they use three categories of common law rules for determining if a worker is an employee or self-employed:
- Behavioral Control – Does the client control your work, and direct how and when the work is completed?
- Financial Control – Does the client determine how you are paid, and provide the tools necessary to do your job?
- Type of Relationship – Do you use an independent contractor agreement stating you will not get any employee benefits from your clients?
The Dangers of Ignoring the Differences
When measuring your relationships against the criteria above, there are several potential dangers from not recognizing and acting on these differences. The most serious of the consequences impact the client because if the IRS determines you are misclassified as an independent contractor, the client will face serious financial penalties. But these penalties can have an ugly trickle down effect on you (i.e., if the client tries to recoup some of their damages by coming after you).
If you are found to be working as an employee instead of an independent contractor, you could also lose some of the self-employed deductions you’ve made on your taxes.
Aside from the financial penalties that may be imposed by the IRS, being treated as an employee instead of a independent worker can severely hinder your profitability and hurt your overall sense of independence. If you are limited to working with just one client and not able to solicit new work, the growth of your business will suffer.
Once you are in a questionable relationship, it can be a difficult cycle to get out of. Many times, creating a clear and independent relationship will require educating your clients on the differences between working with an employee and someone who is self-employed, and being a stickler for ensuring these differences are respected.
Have you ever faced employee/self-employed confusion with a client? How did you rectify the situation?
Image credit: Sigurd Decroos