When an employer mistakenly lists you as a self-employed consultant rather than an employee, the implications of this classification can have a significant effect on your legal rights and the way you pay and file your taxes. Once you’re positive that you’re providing services as an employee, notify your boss and have your tax documents corrected. Before discussing the issue with your boss, learn the key differences between working as an employee and working as a consultant.
Employed or Self-Employed
A person is generally treated as a self-employed consultant when she has a lot of independence and control over her work. An employee, on the other hand, usually has very little control over her schedule, the work must be completed or how the work is completed. However, other factors that indicate an employment relationship, such as paid vacations, health insurance, pensions and other benefits, must be considered as well.
Being classified as an employee is important for purposes of filing your tax returns correctly. Employees are subject to federal and state income tax withholding, meaning that your paychecks are always reduced to pay taxes on your behalf. The annual amount of wages earned and tax withheld is then reported on a W-2 form, which you’ll use to fill in your tax return. In contrast, self-employed consultants receive the full amount of their compensation without any reductions for employment or income tax. Moreover, payments for services are reported to self-employed taxpayers on a 1099-MISC form. Self-employed individuals report their 1099 income on a Schedule C and can take advantage of business expense deductions that aren’t available to employees. But because they don’t have an employer to withhold taxes, self-employed workers are solely responsible for paying self-employment tax -- Social Security and Medicare -- and for making estimated income tax payments to the IRS throughout the year.
Employment Law Protections
A wide range of state and federal laws provide certain legal rights to employees, but not to self-employed consultants. For example, employees have a right to a guaranteed minimum wage; access to workers compensation benefits if injured at work; and job security when taking an unpaid leave of absence under the Family and Medical Leave Act. Moreover, only employees are protected by the Equal Employment Opportunity laws that prevent discrimination in the workplace.
Statutory employees are self-employed for all purposes except employment taxes. In other words, your “boss” would have a legal obligation to withhold Social Security and Medicare taxes from the payments she makes to you, but unlike a true employee, income taxes aren’t withheld. The IRS classifies certain delivery truck drivers; annuity or life insurance salespersons; workers who work at home with material goods or supplies; and some traveling salespersons as statutory employees. But just like an employee, a statutory employee's earnings are reported on a W-2 form -- but with the “statutory employee” box checked off.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.