Independent Contractor vs. Employee – Why It Matters

You are the owner of a small business.  You realize you need help running your business.  You hire someone to help you with the book-keeping, billing, and to send past due notices.  Should the person you hire be considered an employee or an independent contractor?  Does it matter?

Legal Liability

Legally speaking, it does matter.  Businesses that wrongly categorize independent contractors and employees do so at their peril.  Failing to correctly classify a worker as an employee instead of an independent contractor could subject the business to fines, penalties, and even lawsuits.  For example, a class action lawsuit was filed against Uber by drivers who contend that they were misclassified as independent contractors rather than employees, creating substantial potential liability for the company.  Thus, it is vital for a business to categorize those who work for them properly.

Tax Differences

An independent contractor is generally considered self-employed.  As such, they are not covered by labor laws.  Businesses do not have to withhold or pay taxes on the payments they make to independent contractors.  Instead, payments of $600 or more per year that are made to independent contractors are reported on a Form 1099.  Typically, outside accounts, lawyers, and other professionals or specialists retained by businesses to work on discrete projects are considered independent contractors.

In comparison, an employee is someone who works for and is under the control of the business that hired him or her.  A company must pay Social Security and Medicare taxes, as well as unemployment tax, on an employee’s wages.  The business must report all wages paid to the employee per year on a W-2 form.  An employee is also protected by state and federal law, such as minimum wage, overtime pay, and discrimination laws.

Factors to Consider

Whether a worker is an employee or an independent contractor depends on the circumstances.  In making this determination, the independence of the worker and the degree of control the business has over the worker are considered, including the following:

* Does the business supervise and control the worker’s work schedule?
Example:  A worker who has to show up to work at 9:00 a.m. and leave at 5:00 p.m. is likely to be an employee.

* Does the business control what the worker does and how the work is conducted?
Example:  Restaurant waiters who are required to perform their work in a certain way are likely to be employees.

* Does the business provide the tools and supplies necessary for the worker to accomplish the task?
Example:  Electricians who provide their own tools and supplies to complete electrical projects are likely to be independent contractors.

* Is the work performed by the worker an integral part of the business?
Example:  Factory workers who assemble auto parts for a car manufacturer are likely to be employees.

* Does the business provide training?
Example:  Sales clerks who receive training from a business on how to accept payments from customers are likely to be an employee.

* Can the worker work for other companies?
Example:  An IT consultant retained by different companies to help them troubleshoot IT issues is likely to be an independent contractor.

* Is the worker paid on a project basis?
Example:  A roofing contractor who is paid a fixed amount after completing the roofing project is likely to be an independent contractor.

How to Avoid Liability

Unfortunately, determining whether a worker is an independent contractor versus an employee is not black and white; it depends on the weighing of many factors.  One of the ways to protect your business from liability for misclassifying a worker is with an independent contractor agreement.  The independent contractor agreement should expressly state that the person doing the work is an independent contractor, clarify the relationship between the business and the independent contractor, and specify the terms between them.  Although an independent contractor agreement does not provide complete protection from liability for a company, it is a factor that weighs in favor of finding that the worker is an independent contractor.  For an independent contractor agreement template, please click here.