Distinction between hiring independent contractors and employees and things to consider when classifying a worker as an independent contractor or an employee.
What Does it Mean When You Hire Independent Contractors?
Many business owners have people that help them out with the day-to-day affairs of running the business. Of course there are some business owners that are the "jack of all trades" and do everything themselves (can you say burn-out?), but many find that as their business starts to grow, they are very pleased that they are so busy that they need someone to help. Hooray! This is a big milestone for a business.
Most businesses will start out by hiring employees. It may be a secretary, bookkeeper, receptionist, administrative assistant, chief cook and bottle washer, but they are usually employees. Well, I am sure you are sitting on the edge of your seat wondering what the heck makes them employees and not independent contractors?
There are three common law categories of evidence to review in determining whether workers are employees or independent contractors. You should think about each of these three categories in trying to decide if the people you are going to engage to work for you are employees or are independent contractors. You may find it helpful to ask the advice of an experienced attorney to make this determination. The three categories to think about are as follows:
1. Behavioral: Does the employer have the right to control what the worker does and how the worker does his or her job? For example, if you hire a bookkeeper and you tell them the hours you want them to work, and perhaps you tell them how you want your accounts set up and when you want certain reports run, you are exercising control over the way that person performs their job. This is a sign that the person is an employee.
2. Financial: Are the business aspects of the worker's job controlled by the employer? How is the worker paid? Are expenses reimbursed? Who supplies the tools/supplies, etc.? The answers to these questions will be part of your analysis as to whether the people are employees or independent contractors. Think CONTROL=EMPLOYEE.
3. Type of Relationship: Are there written contracts or employee benefits? Will the working relationship continue and is the work performed by the person you engage a key aspect of the business? For example, it would be pretty hard to make a case that a CEO is an independent contractor.
All of these factors must be considered when a business owner analyzes whether to treat a worker as an independent contractor or an employee. The Internal Revenue Service also lists 11 factor to consider:
1. Instructions that the business gives to the worker.
2. Training that the business gives to the worker.
3. The extent to which the worker has unreimbursed business expenses.
4. The extent of the worker's investment.
5. The extent to which the worker makes his or her services available to the relevant market.
6. How the business pays the worker.
7. The extent to which the worker can realize a profit or loss.
8. Written contracts describing the relationship the parties intended to create.
9. Whether or not the business provides the worker with employee- type benefits, such as insurance, a pension plan, vacation pay, or sick pay.
10. The permanency of the relationship.
11. The extent to which services performed by the worker are a key aspect of the regular business of the company
Effect of Classifying Worker as Independent Contractor
Okay, why on earth does any of this even matter to you? I am sure that is the question that is running through some of your minds. If a person that is working for you is properly classified as an independent contractor and is not an employee, you do not have to withhold income taxes or Social Security taxes from the person's pay. BUT, even better, if the person is an independent contractor, you do not have to pay the employer's contribution to the worker's social security fund. That could be a nice chunk of change to save, but only if the person is truly an independent contractor. In addition, employers do not have to pay workers' compensation benefits, unemployment benefits, health benefits, and other expenses associated with hiring employees.
A note of caution to all of you who are jumping up and down thinking how much money you will save by reclassifying all your "employees" as independent contractors. Many employers are tempted to classify every worker as an independent contractor, because who would not want to save all that money? However, our the IRS is wise to this. The IRS believes a lot of tax dollars have been lost as a result of workers being misclassified as independent contractors (the employer does not pay taxes and the "independent contractor" neglects to pay its taxes). As a result, the IRS has put into effect (notice I did not say "has enacted" - I am trying not to go into robotic legal mode here), strict tests for determining whether a person is an employee or an independent contractor. If you misclassify someone as an independent contractor that should have been classified as an employee, you could be subject to investigations by the United States or state Departments of Labor (scary). Misclassification can also lead to the monetary liabilities and fines.
If you are unsure of how to classify a worker, seek e advice of an experienced attorney.
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