What's the difference between an independent contractor and an employee? It's important to classify workers correctly.

For payroll tax purposes, workers are generally classified as employees or independent contractors. Whether a worker is an employee or an independent contractor depends on the amount of control the employer has over the worker.

What's the difference between an employee and an independent contractor? A worker's classification has certain payroll tax implications. Basically for employees you pay payroll taxes (like Social Security), but for contractors you don't have to. A few simple questions can help you determine whether the person you're hiring is an employee (and will need a tax form W-2) or an independent contractor (and will need a tax form 1099).

• Will the work be performed on company premises? ·
• Will the individual work only for you? ·
• Will you provide tools for your worker to do his or her job? ·
• Do you control the hours the person works?

If you answered "yes" to any of the questions above, odds are you're hiring a W-2 employee, and not a 1099 independent contractor. For more detailed information on how to classify a new hire.

While it's tempting to pay someone as an independent contractor since it's less expensive, it could get you into trouble later. In fact, the IRS has started cracking down on employers who classify their workers incorrectly.

How much does it cost to hire an employee? It's more than just paying a salary.

For every employee you hire, you are responsible not only for each employee's compensation but also for each employee's associated payroll taxes.

Let's say you hired a W-2 employee named Nick, and you wanted to pay Nick $10 per hour. On top of all the deductions taken from Nick's paycheck, you, as the employer, will also have to pay payroll taxes and other expenses (also known as liabilities). The table below gives you an idea of what those payments might look like:

Payment Percentage of employee's gross wages that the employer must pay

 

	Social Security	6.2%
	Medicare	1.45%
	Federal + state unemployment insurance	2-6% (this varies — 4% is typical for new employers)
	Workers' Compensation insurance (varies depending on insurance provider and type of work being performed)	5%
	Other local payroll taxes (depends on location)	1-2% (local taxes paid by the employer are usually a flat fee per employee ranging from $2-$4 or a percentage of total payroll for all employees)
	Total:	15%

So, for every $10 you pay Nick, it will actually cost you about $11-12 dollars per hour to employ him. Keep in mind that this is roughly how much it will cost before offering any employee benefits, providing any work supplies (like a computer) or spending time training him. As a general rule of thumb, depending on your state and local laws, payroll taxes can add 15% or more to the total cost of hiring an employee.

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