Independent Contractor or Employee?

Sep 26, 2018 | Human Resources, Payroll

Many times, businesses use the services of someone that they believe is an independent contractor.  The individual does not want to be an employee and the business is happy with an independent contractor arrangement.

But, are there underlying conditions that would cause this person to be an employee?

It is critical to correctly determine whether individuals providing services are employees or independent contractors. Failing to properly classify a worker can cause exposure to possible fines and penalties.

Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services.

Consider the following aspects of each type.

Common-Law Employee

In a common-law employee relationship, the business owner has the right to control what will be done and how it will be done, even if the person has freedom of action.  What matters is that the employer has the legal right to control the details of how the services are performed.

Facts to consider fall into three categories:

  • Behavioral: does the company control, or have the right to control what the worker does and how the worker does the job?
  • Financial: are the business aspects of the worker’s job controlled by the payer? (how the worker is paid, whether expenses are reimbursed, who provides tools, etc.)
  • Type of relationship: are there written contracts or employee benefits?  Will the relationship continue and is the work performed a key aspect of the business?

No single factor can determine whether the person is an employee or independent contractor.  Factors are situational and may be relevant to one relationship and not another.

Generally, income taxes, Social Security and Medicare taxes are withheld, and unemployment taxes are paid on employee wages.

Independent Contractor

Independent contractors offer their services to the general public.  These might include people such as doctors, dentists, lawyers, accountants, or contractors, who are in an independent trade, business or profession.  The general rule is that the person for whom the services are performed has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

An agreement or contract between a worker and a business does not determine an independent contractor’s status.  As with the common-law employee, you must consider many factors to determine the proper classification.

The business does not withhold or make tax payments on independent contractors.  Independent contractors are self-employed and responsible for Self-Employment Tax.  Self-employment tax consists of Social Security and Medicare taxes.

Statutory Employee

The third category of workers – statutory employees – can enjoy the best of both worlds.  They are like independent contractors but without substantial investment in the facilities used in the performance of services.

Examples of statutory employees are, drivers who distribute certain goods, full-time life insurance sales agents, individuals who work from home on materials that a business supplies or certain full-time traveling city salespersons who turn in orders to the business.  The IRS has specific guidelines for these statutory employee categories.

Perils of Misclassification

Besides potential fines and penalties, employers who misclassify workers could also face other risks.

What if a worker is classified as an independent contractor and becomes disgruntled, claiming he is really an employee?

Then that worker quits and files for unemployment.  If the business cannot substantiate an independent contractor status it may become subject to back unemployment taxes as well as other withholdings.

Or, what if that same worker decides he should have been an employee and makes an ERISA claim that he was not properly offered employee benefits?

Or, claims he should have been paid overtime?

Many things can go wrong if workers are not properly classified.  Sorting out these issues can cost a company time and money.  If in doubt about how to classify a worker, seek counsel from an experienced HR or legal professional.

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