This question is one of the most commonly asked, frequently misapplied, and riskiest to the employer if a worker is misclassified. Let’s explore the differences in an Independent Contractor and an Employee and some of the common misperceptions.
An employee is an individual that you pay to perform a job or service for your business. But, wait, so is an independent contractor. The differences lie in the relationship and control between the business and the individual. In general, with an employee, the business owner controls when the person comes and goes, where they work, and how they perform the work. With an independent contractor, a business engages that individual to do a job or perform a service, but does not have as much control over when they do the job, where they do the job, or how they do the job. Another difference is whether the individual performing the job is paid exclusively by the small business (employee) or whether that individual holds out the same services to the public and is paid by other customers (contractor). Another differentiating feature is who provides the tools to do the job. A contractor would have his own publishing software, or knife sharpening truck, or crane to remove dead tree limbs, to cite some examples. An employee would be provided the tools necessary to complete the job by the business owner. The manner by which an individual is compensated can also impact an employee vs. contractor test. Employees are typically paid on a set schedule, like every other Friday, and their expenses they incur are reimbursed. Contractors typically create a contract with a small business and send a bill when the work is complete as well as paying for their own expenses incurred on the job. The IRS has two Relationship Tests for determining status: The Common Law Test (20 Factor Test) and the newer Three-Factor Tests. Links to both are below:
You may be asking yourself: Why does it matter anyway? There is typically significantly less cost and compliance involved in paying a contractor than an employee. Employees have taxes withheld and receive a traditional paycheck and W-2 where contractors receive the full amount agreed upon for the job. Employers must pay State and Federal Unemployment taxes and Workers’ Comp insurance on employees and usually do not incur these costs for contractors. Employees may be eligible for all kinds of company benefits like health insurance, 401k plans, and vacation or sick pay, where contractors are not eligible for these benefits. Employers must pay the employer share of Social Security and Medicare which adds 7.65 % in cost to every dollar paid to an employee while independent contractors bear these costs themselves. For these reasons, government agencies like the IRS, DOL, and state employment agencies believe there are instances where employers will misclassify workers to save money and transfer the compliance, benefits, and tax burden to the individual. These agencies tend to rule on the side of the employee classification when the relationship is unclear. The penalties for misclassification can be severe. When in doubt, err on the side of the employee classification or seek legal advice.
Here are some common misconceptions and errors we have heard over the years:
- “Bob and I agreed that I will pay him as a contractor.” The classification of whether an individual is an employee or contractor is determined by the relationship tests, not what you or the individual want or agree to.
- “Tina only works once a week on Saturday mornings so I’m going to pay her as an independent contractor.” How often or how little an individual works has nothing to do with whether they are an employee or independent contractor.
- “Frank waits tables at two other restaurants in addition to mine so he is holding that service out to the public and is an independent contract.” In this instance, Frank still has a scheduled shift, gets paid every two weeks for the hours worked, wears your uniform, and is assigned to wait on particular tables by you. He is an employee.
- “My employee Frances learned that we were paying the office cleaning service $150 to clean the office, and offered to do the work on her day off as she could use that money. I am going to pay her as an independent contractor for that work but as an employee for her regular work.” Individuals are, by definition, either employees or contractors-they can’t be both. Her Saturday wages are also employee wages.
Hopefully this Blog Post has been informative as you make decisions on whether individuals are employees or independent contractors. Checkright includes the following disclaimer. Employment law is a complex topic that changes all the time, and this article is not comprehensive, and statutes and rulings may have changed since its publication. This blog post was meant to inform and speak in generalities, not inform your specific decisions. Always seek legal counsel when in doubt as to employee classification.