Employee Versus Independent Contractor: What's The Difference?

This is a guest post by our friends at Priori Legal. Co-founder and CEO Basha Frost Rubin runs you through the differences in status and tax filings for employees and contractors, and how to ensure you're following the law (and avoiding penalties!).

From a financial standpoint, hiring independent contractors seems like a no-brainer: unlike employees, independent contractors are not automatically entitled to minimum wages, overtime pay, unemployment benefits, and workers’ compensation.

Besides, the laws governing the distinction between employees and independent contractors are multifaceted, and can be confusing for many: what if your worker wants to be classified as an independent contractor? What if you don’t own an office, and all of your employees work from home? And so, eager to save on labor costs, many business owners accidentally overlook the laws surrounding the distinctions between employees and independent contractors.

Yet misclassifying employees can result in serious consequences: your company may owe back taxes and penalties to the state and federal governments for unpaid income taxes, social security, Medicare and unemployment, and need to reimburse the worker what you ought to have paid under applicable wage and hour laws. Rather than saving you money, improperly classifying your employees can cost you -- big time.

The stakes are high, and with the IRS, the Department of Labor, and multiple state governments teaming up to crack down on the misclassification of employees, it’s important to educate yourself about the rules before you make an expensive mistake.

Legal Distinctions

The IRS offers a three-prong standard to assess whether a worker is an independent contractor or an employee.

• Behavioral: The IRS states that “a worker is an employee when the business has the right to direct and control the worker.” Behavioral control is asserted through the type of instructions given, the degree of instruction, evaluation systems, and training.

• Financial: When establishing a worker’s status, a business owner needs to factor in the amount of economic control he or she has over the worker in question. The IRS lists the following as facets of the employer’s economic control over a worker: worker investment, unreimbursed expenses, the potential for profits and losses, the business opportunities the worker can seek outside of the employer’s company, and the method of payment.

• Type of Relationship: The IRS defines the employer-worker relationship as “how the worker and the business perceive their relationship to each other” as established by written contracts, employee benefits, the length of the relationship, and the type of services the worker provides.

Confusing, right? To add to it, the Department of Labor and individual state governing bodies have their own guidelines to follow and evaluate. But here’s what is clear: neither the existence of an independent contractor agreement nor the fact that a worker wants to be treated as an independent contractor will suffice to stave off potential liability.

Lawyer Up

Given how costly mistakes can be and the somewhat blurry and overlapping nature of the guidelines, consult a Priori lawyer to make sure you are classifying your workers appropriately and to help you make proactive decisions about how you manage workers so you don’t get into hot water.