Whether to hire an independent contractor (1099) versus an employee (W2) is a real problem facing a business. The consequences for getting it wrong can be huge extending into a business owner's personal assets.
What Defines an Independent Contractor Versus and Employee
The most important thing to think about is the issue of control. Ask yourself “To what extent do you control how the person you hire does the job?”
The contractor controls where he/she does the job;
The contractor uses his/her own tools to complete the job;
The contractor controls when he/she does the job;
The contractor controls how he/she does the job;
The contractor is free to solicit work from other people;
You give very little to no direction to the contractor; and
Your say regarding the contractor’s work is little more than telling the contractor what you want the final product to look like.
There are other factors, but these give you a good start/feel to guide you.
In addition to factors that are the hallmarks of an independent contractor, there are common hallmarks for what constitutes an employee.
You control where the person does the job;
The employee will use your tools and facilities to complete the job;
You control when the employee does the work (be here from 9-5, for example);
You give direction to the employee as to your methods of how he/she is to complete the job;
The employee generally has a duty of loyalty to you and you can insist that the employee not work for a competitor; and
Your say extends to the methods and processes of doing the work well beyond merely the final product.
These are some factors to look at regarding the differences between an independent contractor and employee. You can see from the factors that describe each that there are benefits to control and to not having control that are inherent in the factors. However, there are also significant differences in your obligations to each and which laws do and do not apply to them.
Legal Obligations Beyond the Factors of Control - Independent Contractors
There are very few legal obligations as it relates to labor and employment laws for independent contractors. Discrimination laws generally do not apply to them, though there can be some prohibitions regarding terminating a contractor based upon some protected status (based upon a person’s religion, sexual orientation, race, etc.).
Legal Obligations Beyond the Factors of Control - Employees
There are considerably more obligations for an employer as it pertains to how it treats employees.
Depending upon the number of employees a business has, New York State anti-discrimination laws apply. If an employer is in New York City, the city has a human rights law that applies as well. For New York State, when an employer has 4 employees, the state human rights law applies to that business, the same goes for New York City.
You may be wondering, if you are an employer in New York City, and the New York State and New York City laws apply, isn’t this redundant. You are correct in some areas. However, New York City laws can be more protective of employees. For instance, asking a prospective employee about his/her criminal record is not legal within the City. It’s not a proscription state-wide.
While there is, generally, just a single law in New York State and New York City that proscribes all sorts of discrimination, federal laws are more piecemeal. For instance, discrimination based upon race is a law called Title VII of the Civil Rights Act of 1964. Proscriptions on age discrimination are covered under the Age Discrimination in Employment Act. The Americans with Disabilities Act covers discrimination based upon disability. However, these laws don’t begin to apply until you have at least 10, 15, or 20 employees, depending on the law. That is a topic we can get into at a later time.
This can be one of the riskiest situations because the labor laws implicate paying of wages and statutory penalties and fines for not doing so or doing so improperly. While there is not the number of employees threshold as there is with the employment laws, exposure for misclassifying your workers can be very costly.
The most onerous is the workers compensation law in New York State. First of all, every employer is required to have workers compensation insurance for their first employee. If an employer does not have it, the penalties for not doing so can run into the thousands. Moreover, under New York Law, the state will hold the top officials in the company personally liable for any penalties, interest, or other fines. You read that right. The corporate veil will not protect you.
So, what does this have to do with the independent contractor/employee question?
Many are the companies who classify workers as independent contractors only to have the state come in and assess that the business exercised sufficient control over them such that the state will find that they were actually employees and begin assessing fines, etc. As I said above, fines and fees can run into the thousands.
An independent contractor is responsible for paying his/her own taxes. All the business must do is present a 1099 to the contractor at year’s end. The contractor takes care of all of his/her tax obligations.
Employees are markedly different. The employer must worry about withholding taxes from paychecks. The employer pays its half of social security tax. The employer may have an obligation to provide health insurance.
What’s the Lesson Here?
It’s quite simple. Assess your needs and how much control you want to have over workers. If you can give up control, you can save a lot of money and headache. However, do not misclassify them. If you are unsure whether the control you may exercise is sufficient to have a third-party, namely New York State, “reclassify” them as employees exposing you to huge fines and expenses (and possibly jeopardizing your business), err on the side of classifying them as employees. It may cost you more with compliance costs and having to take care of taxes, but it will save you immeasurable amounts of money.
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