Why You Need To Understand The Difference Between Independent Contractor, Self-Employed, And Employee

On the surface, it seems straightforward.

  • Either you’re self-employed or employed.
  • You either work as an independent contractor, or you do not.

So, what’s the problem?

Well, when it comes to the classification of workers, things are not clear cut. And it leads to confusion.

You see, every day we get questions and read through comments. And over time we’ve noticed there’s confusion between three classifications:

  • Independent contractor
  • Self-employed
  • Employee

The Confusion

Some Nurse Practitioners think they work as independent contractors when they function as employees. Others work as independent contractors but don’t view themselves as being self-employed.

And it gets even more complicated when someone with a fulltime job works a side hustle to bring home extra cash.

But no matter the situation, it’s critical you choose the correct classification; and it doesn’t matter if you’re the worker or the person hiring help.

Because if you don’t, you could get yourself in a heap of trouble not only with the IRS, but also with local, state, and federal agencies. 

It’s The Same

But before we jump in, let’s get one thing straight. If you work as an independent contractor (IC), you are self-employed; the two are one and the same.

Independent contractors are known and go by different names. Some examples include freelancers, gig workers, contract workers, small business owner, creative professionals, to name a few.

While all refer to a self-employed individual, they don’t indicate legal entity status, such as sole proprietor or LLC… that’s a different topic altogether.

So now, let’s talk about what it means to be employed and what it means to work as an independent contractor or self-employed individual.

Self-Employed

When you’re self-employed, you’re required to pay self-employment (SE) taxes. Self-employment (SE) taxes are the independent contractor version of paying Social Security and Medicare taxes. SE taxes do not include income tax.

Since there’s not an employer paying part of your Social Security and Medicare taxes, the percentages you must pay are slightly higher. It’s because you’ll be paying all of it.

As a self-employed individual, you are required to file an annual return and make quarterly estimated SE payments. You’ll report your business income/loss on Schedule C, which attaches to IRS Form 1040, your personal income tax return.

Of course, this particular scenario does may not apply to every independent contractor and may be different for you; filing requirement varies based on legal entity selection.

Employed

When you’re employed, you’re also required to pay Social Security and Medicare taxes. While most employees know this, they aren’t always aware of it. That’s because all of it is done for them and happens in the background.

The employer is required to withhold the appropriate payroll taxes, including social security, Medicare, federal income and unemployment taxes; the employer must also file reports and deposit the withholdings. And, there are additional state withholdings.

I know, it gets complicated…

But here’s the thing: regardless if an employee is full-time, part-time, or even seasonal, the withholding rules still apply. When a person is classified as an employee, the employer is required to withhold, file reports, and make payments on behalf of the employee.

It’s About Taxes

That’s what it comes down to… someone has to pay taxes. It’s either the employer or the independent contractor.

The problem is, nobody is keen on paying taxes. Some even try to wiggle their way out of paying.

Not too long ago, there’s been an extreme case. An employer changed the status of its workers from employees to independent contractors.

Can you imagine the savings for the company and the headache for the employees?

  • Since employees now were ICs, the company no longer had to withhold, match, or deposit on behalf of its workers.
  • And benefits… paid to employees only.

It’s no surprise the case lead to a lawsuit. Consequently, the IC laws were tightened in four states, including California, New Jersey, Massachusetts, and Illinois.

If you live or work in any of these states, make sure you read our article about these recent changes.

The Rules

But now, let’s look at the rules and guidelines used by the IRS. What constitutes IC status and what does not?

When evaluating IC or employee status, the IRS looks at the degree of control and independence exercised by the IC or employer across three categories.

Here are the highlights from each category:

  • Behavioral control:

Who has control over how the worker completes work or what the worker does? The company or the worker? The more behavioral control a company has over the worker, the more the likeliness the worker is an employee.

  • Financial control:

Who pays for expenses associated with the work performed? Is the worker reimbursed by the business or are expenses paid by the worker? How is the worker compensated: with a flat fee, one-time payment or through ongoing payments? Typically, employees are reimbursed for business expenses and receive ongoing payments, while IC’s do not.

  • The Relationship between two parties:

How do the business and the worker view their relationship? Are there written IC agreements in place? What is the length of the working relationship? Most employees are brought on for the long term, whereas the IC relationship often has a limited time horizon.

As you can see from the partial list above, the IRS looks at many factors to determine whether a worker qualifies for IC status or not.

It’s important to note that every case is unique. While it seems two similar situations would yield the same result, each must be examined on its own merit. Even though similar, one situation may qualify for IC status while the other may not.

Learn More

I encourage you to learn more about IC vs. employee status. Nolo, the do-it-yourself legal book publisher, provides a comprehensive overview of the topic in “Working With Independent Contractors.”

Also, the IRS provides a variety of information, which you can find here.

Additionally, you may consider getting professional help if you find yourself struggling with determining the proper classification.   

The Consequences

I’m sure by now you realize just how important it is to pick the correct classification…

Misclassifying workers may not only result in costly fines and penalties but cause major headaches too. Here are some of the things that may happen when someone is misclassified as an independent contractor when it should be an employee.

There will be:

  • Back taxes and penalties to pay, potentially going back three years
  • Back payments to state and federal agencies, such as unemployment insurance and workers’ comp.
  • Potential penalties from various state and federal agencies.
  • Potential criminal action if misclassification is found to be intentional.  

In Summary

If you are a business and decide to work with an IC, you only pay the agreed upon rate for services to be rendered. There are no further obligations on your part; you are not required to withhold or pay taxes on payments to the IC.

The only other thing you must do is issue Form 1099 to the IC end of the year. On it, you report to the IRS how much you paid to the IC.

However, if you hire an employee, you are required to withhold not only income taxes, but you must also withhold and pay Social Security and Medicare taxes. Additionally, you must pay unemployment tax on any wages paid to the employee.

At the same token, if you work as an independent contractor,  you must report and pay all required federal and state taxes as discussed above.

And here’s one more thing…

Don’t allow yourself to be misclassified by someone. We’ve heard about NPs contracted as ICs, when in reality they function as employees.

In conclusion, if you are a business owner or you work as an IC, it’s critical you understand these definitions and abide by them

Have you run into any issues with ICs? What’s your experience been when it comes to independent contracting? Why not share it with us, so all of us can learn from it!

 

By Johanna Hofmann, MBA, LAc; regular contributor to the NPBusiness blog and author of “Smart Business Planning for Clinicians.

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  1. Hi Felicia, Whenever you move states, it’s critical there you become familiar with the laws in which the state you are in and make sure you are within the scope of practice for that state. Furthermore, if you are going to practice across states lines, you need to have licenses in the states where your patients are and need to adhere to those scope of practices as well.

    Florida being a red state is going to require collaboration, which you don’t need in AZ. If you work with insurance, you’ll also find changes there as well.

    Hope that helps!

  2. In the case of an employed NP leaving a private primary care practice, who bears the onus of mitigating patient abandonment issues? The practice or the NP?

    If the employed NP leaves one practice and immediately begins working in the same capacity for a different employer in the same community, does this impact the NP’s risk of patient abandonment?

  3. Hello Allison,

    In all the years I’ve been working, I’ve never heard of an NP being held for responsible for patient abandonment when he/she leaves employment (assuming the usual notices) and starts a new position. That said, I’m not a lawyer and I don’t know the circumstances behind this question. If there is a concern, you’d be wise to consult with your attorney/malpractice.

    Best wishes!

  4. Hello Barbara,
    I am starting a primary care consulting business in a correctional facility. We are three NPs and a collaborating MD. We are ICs. My question is: what is the process to create a 1099? Do you think I should hire an accountant for payroll or since we are only 4 providers I should be able to self manage? Any recommendations? Thank you

  5. The company (in whatever structure) would contract with the NPs to provide services. You do not have “payroll”. With ICs you do not pay taxes or benefits of any kind. You’ll pay them the contracted fee. At the end of the year, there are several options to generate 1099s for each of the contracted NPs.

  6. Hi!
    If I am employed full time and want to have a side business doing botox injections, can I be a 1099 IC if it’s just me or do I need to start an LLC and then be employee of? Thanks!

  7. If it’s your own business, you’ll want to go ahead and form an LLC for a variety of reasons. As 1099 you still want to have a corporate structure and LLC (assuming you can do that in your state) is the way to go.

  8. Hello….
    I was offered a part time position at a local urgent care (27 hours). I also was offered a 1099 position doing in home assessments for Medicare and Medicaid. Unsure if I need to get a LLC for this?

  9. Working as an independent contractor means you have a business and you should treat it as such. Every state has different requirements for creating business structures, and your state may require something other than an LLC. You can likely find that information on the website for the Secretary of State. Recommend talking with your CPA to determine what is best for you tax-wise.

  10. I was hired as an Independent Contractor to work for an MD own company doing telehealth. No benefits etc… Why would they refuse to pay my LLC, and only want to pay me directly? It would save me taxes. It shouldn’t matter since I am not an employee. This company is based in California, but function in 40 states. I reside in another state, so they require the ICs to get two additional in CA and NY.

    I was told my attorney it shouldn’t matter and advise by my CPA to have them pay my LLC, otherwise it doesn’t make good sense due to the taxes it would cost me. I pass on the contract, just was wondering why they would refuse.

  11. I have no idea why they would refuse to pay your company. In either case, and an IC in California, there is an issue. I’m going to refer you to a video I did with Melanie Balestra, NP, JD about the rules in CA. This may be the reason, but it does not matter if it’s you or your company. https://youtu.be/equ_hceI85s

  12. I am an IC in Texas and I was wondering if I should have an LLC for this. I have been working at a clinic for 3 months now and I am on the fence with starting one. I had to pay for my liability insurance and I am just curious for a legal standpoint if this is recommended.

  13. You should have a structure for your business, yes. You’ll want to talk with your CPA to find the best one for your financial situation. As an IC, you are a business owner and thus are responsible for all your expenses. The good news is that many/most of those expenses are going to be a business tax deduction.

  14. The state I am residing in allows a PLLC and I am looking to form one for myself, as I am planning to start doing IC work. I would think that I could be subcontracted by another LLC (np-owned) to do some work, if a favorable contract could be negotiated. I don’t see how this would be any different than my POA LLC contracting with our road maintenance or CPA LLC….at least from a business standpoint, except that there are third party payers involved, so fees/rates/billing could be tricky..,,,,In these instances, do ICs set their rates and bill for their services usually? Thanks in advance.

  15. Virginia,
    Yes, you can do that, providing your state laws allow it. Please make sure you are looking at your state employment rules as to what constitutes an IC – specifically look for ABC rules or ABC test. We are seeing more states bringing those rules on board.

    For clinicians that are still working in this manner, I see both % of revenue and setting fees for work. The fee method is more in line with IRS rules.

  16. I work full time as an NP for a physician who gives me a W2 at the end of the year. I have been there for 2 years. About two weeks ago , the administrator had me sign a W-9. When I questioned it , not ever having heard of a W-9 , she reassured me it was fine, I was still an employee, and my taxes would not change. Now , after reading , I am becoming very regretful about having signed it. I am not an independent contractor by any means. Do you have any idea why they have done this? Is it going to create an IRS nightmare for me?

  17. Hi Laura,
    If you are still getting a paycheck where taxes are being withheld, then it was likely a simple mistake on the administrator’s part. You could download a W4, fill it out and give it to her and say you thought this was what you were supposed to sign and that the W9 is for independent contractors.

    If she did intend you to sign a W9 and they are still with-holding taxes as well as paying any benefits, then they are in the wrong, and misclassification of employees can result in state fines to them.

    That said you definitely want to get clarification.

  18. I am a new FNP starting in a new Florida practice soon. No negotiations have begun as of yet. I just don’t know what would be best, IC or employee. I’m trying to investigate pros and cons, I don’t need health benefits, I would like to deduct my own expenses. What are the cons of IC when just starting out in practice.

  19. Susan,
    Becoming an IC can have benefits in terms of business deductions. You have to cover all your own expenses, including malpractice and your own taxes. The thing to take a look at, however, is if this position actually qualifies for IC status. Many states have been clarifying exactly what an IC is, including Florida. https://www.dms.myflorida.com/workforce_operations/retirement/section_218_agreements/independent_contractor_determinations

    ~Barbara

  20. If I create an LLC, does the malpractice insurance need to be under a business or can I still cover myself as an individual?

  21. I am IC NP. I have been given a choice to pay out the current owner for a huge amount or leave the practice. I was given a deadline of three days. I am not buying a failing practice so I said no. I was told my last day is wed and I will have 48 hours to close all notes. I have built my own practice. I never signed a contract. Can I take my patients with me. Also is there anything I can do to ahold her accountable for doing what she is doing. There is no transition of my patients.

  22. You are not an employee of this practice, and the patients are probably not be seen as “yours”. Unless this practice owner has done something that is illegal or unethical, you probably have no recourse other than to report them to their state board. As for the patients, they always have the choice of where they want to receive their care.

  23. I am a PMHNP and got hired as an IC in Nevada where I live, am I required to get a business license? and if I am, what type should I get? sole proprietor or LLC ?

  24. Hello I am offered to work one day a week as an NP in private practice , for possibly a year or two. I was told no benefits , no withdrawals for taxes, and as an independent contractor.
    Is it the correct classification in this case.

  25. That sounds about right. However, it must follow the rest of the IC guidelines, so be sure to take a look at the IRS AND your state employment office. They may have rules that are more strict (look for ABC rules).

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