Independent Contractor vs. Employee


Businesses love growth and hiring new workers is the key to growth.  Problems may arise, however, when businesses try to define their relationship with newly hired workers.  Is a newly hired worker an employee?  Or, is the newly hired worker an independent contractor?

It may be tempting to classify workers as independent contractors because employers are required to pay Medicare and Social Security taxes and unemployment taxes for employees and may also incur additional payroll and administrative costs for employees.  On the other hand, employers are NOT required to withhold for independent contractors and independent contractors usually do not require benefits that employees require such as insurance and retirement plans.  Thus, it is generally cheaper (and easier) for employers to hire an independent contractor as opposed to an actual “employee”.

But, employers must ask important questions as to how to classify a worker because mislabeling can lead to serious tax consequences, fees and other headaches.  For example, serious back taxes can result from an IRS challenge.  The headache of going through a challenge is not fun either and the process can be a nightmare for a business owner who is trying to also maintain and run a business.  Not many business owners like the additional attorney’s fees and/or accountant’s fees that may also be associated with a challenge.

Unfortunately, there is no “magic” way to determine a worker’s status.  The IRS does, however, give us a three part, fact specific test to help differentiate between an independent contractor and an employee:

  1. Behavior;
  2. Financial Relationship; and
  3. Type of Relationship.

 

(1) Behavior

Definition:  The degree of freedom a worker has in choosing and completing tasks. 

Independent Contractors typically:

  • have more control over when, where, and how to work;
  • are given less detailed instructions;
  • are evaluated by their end-result work product (instead of as an individual); and
  • do not receive initial, periodic or ongoing training

 

(2) Financial Relationship

Definition:  The manner in which the worker is paid and reimbursed. 

Independent Contractors typically:

  • purchase, own and maintain their own work equipment;
  • receive less (or no) reimbursement for expenses;
  • risk losing money on particular projects;
  • maintain their own business location;
  • seek other business opportunities (or even advertise); and
  • are paid hourly or on a flat fee (employees are usually salaried)

 

(3) Type of Relationship

Definition:  The nature of the relationship based on the type of contract, benefits, longevity and importance provided to the worker.

Independent Contractors typically:

  • do not receive benefits, sick days, pensions, insurance or paid vacation;
  • are hired on a project-by-project basis;
  • do not perform services considered as key activities of the business; and
  • do not have their work presented as the work product of the business.

Simply naming a contract an “Independent Contractor Agreement” or an “Employment Agreement” will not be conclusive determination as to the nature of a company’s relationship with a worker.  The factors above will make the final determination.  While no one factor is determinative, the more factors indicating the worker is an independent contractor, the better argument an employer has when and if the IRS comes calling.

 

Written By:

 

Patrick R. Norris, J.D., Norris Legal, L.L.C.

Chris Lessard, Clerk, Norris Legal, L.L.C.

 

Thank you for reading this article.  The information contained in this article is for discussion purposes only.  The information contained in this article is not legal advice upon which you should act and simply reading this article does not make you a client of Norris Legal, L.L.C. or any other law firm.  Thank you again.