In your business, you may be wondering if you should hire an independent contractor or an employee for work that needs to be done. Before making that decision, it is important to understand the difference between the two because it will affect your business from a tax standpoint, and there are costly legal consequences if you aren’t clear about each role.
In general, the difference between an independent contractor and an employee depends on the amount of control that the employer has over the work being performed and how a work day is designed. The following outlines some of the major differences between the two.
An independent contractor falls under the following criteria:
- Operates under own business name
- May have more than one client
- Bills for work completed
- Maintains own business checking account
- Keeps business records
- Advertises for business’ services
- Provides own tools and material for each job
- Sets own hours
- Responsible for the costs associated with performing the job
- Subject to self-employment tax
- Ineligible for employee benefits, unemployment compensation, and worker’s compensation
- Usually not protected by anti-discrimination and safety laws in the workplace
Many small businesses and even large corporations rely on independent contractors for specific staffing needs. Some of the benefits to employers include flexibility in hiring and firing, reduced liability, and savings in labor costs.
Employees fall under this criteria:
- Work performed is controlled or dictated by others
- Works for only one employer
- Is given training for work to be done
- Follows hours and rules set by employer
- Employer is responsible for costs related to performing job
- May receive benefits, unemployment compensation, and worker’s compensation
- Has protection of employment anti-discrimination and workplace safety laws
Legal Consequences of Misclassification
Sometimes it can be difficult to determine how to classify someone working for you, which leads to misclassification. Other businesses purposely misclassify someone as a way to escape employment law responsibility and to shift costs from the organization onto the worker. In either case, if employers are not clear about what classifies an independent contractor or employee, there may be legal consequences. If an employee is misclassified as an independent contractor, an employer may be required to do the following:
- Reimburse wages that should have been paid, including minimum wage and overtime. These are defined under the Fair Labor Standards Act.
- Provide employee benefits including retirement, health insurance, sick leave, vacation time, etc.
- Pay back penalties and taxes for state and federal income taxes, Medicare, Social Security, and unemployment.
- Pay any workers’ compensation benefits due to the employee.
Employment Status Test
In order to determine the classification of a worker, there are different versions of a test that help establish independent contractor or employee status. Most tests ask about different factors, which often include the following:
- Instructions: employees are instructed as to how work is to be performed, while independent contractors use their own work methods.
- Training: employees receive on-the-job training, while there is usually none for independent contractor.
- Full-time status: an employee must devote full-time hours to employer, while an independent contractor cannot be required to commit to full-time service.
- Services rendered: an employee must render services personally, while an independent contractor can assign someone else to perform the job in his or her place.
- Hiring and paying an assistant: if any employee hires a helper, the employer pays. If an independent contractor hires anyone, the pay is their responsibility.
- Continuing relationship: an employee usually continues working for the employer for a long period of time, while an independent contractor is hired to do one job of limited duration.
- Location: an employee must perform services in the location decided by the employer, while an independent contractor can choose to work wherever.
Understanding the difference between independent contractor and employee can mean the difference in your compliance with tax laws. Determine what category your worker falls into, and do your research to make sure you are following the appropriate legal requirements for each.
The content on our website is only meant to provide general information and is not legal advice. We make our best efforts to make sure the information is accurate, but we cannot guarantee it. Do not rely on the content as legal advice. For assistance with legal problems or for a legal inquiry please contact you attorney.