For some of your business tasks, working with an independent contractor can be win-win. You have fewer tax responsibilities and paperwork, and the contractor has greater freedom and flexibility. But in many cases, business relationships get closer than they were originally intended, and you may begin to ask yourself just how “independent” your contractors actually are.
The rules around what makes workers independent contractors vs employees can be confusing. But they are also important; incorrectly treating an employee as an independent contractor can cause real problems and be costly for your business if you are audited. In this post, we’ll walk you through the distinctions between the two, so that your business can make the right decision.
Misconceptions About What an Independent Contractor Is
Most businesses find independent contractors more attractive as an investment than employees. They are generally less costly and more convenient, both of which can be important factors in a small business environment. But even if you and your worker agree to an independent contractor relationship, that’s not enough. Here are three common misconceptions about what can allow you to hire an independent contractor:
- Small Employers
A very small business can find it difficult to pay the taxes and insurance costs associated with hiring an employee. Calling the worker an independent contractor can seem like the perfect solution, but neither the IRS nor the US Department of Labor considers the size of a company to be a factor.
- Infrequent Work
When a job is only performed a few times a month, it seems counterproductive to go through the hiring process. After all, the worker can’t possibly qualify for benefits! However, if the work falls under the parameters of an employee, then it doesn’t matter how frequently it is done.
- Temporary Job
Sometimes your business will have a task that needs to be done just once. For example, your business could have disorganized financial books; working with a bookkeeping service in Atlanta can be the right solution. A job like this is often handled by an independent contractor, but it’s not the temporary nature of the job that makes it non-employee work.
These three scenarios mark times when independent contractors are often used. But as you can see, that doesn’t mean that an arrangement under these criteria actually is legally an independent contractor agreement. Instead, you have to pay attention to three specific rules set out by the IRS to ensure you’re not overstepping their boundaries.
What Does Matter?
The distinction between independent contractors vs employees really comes down to the behavioral, financial, and relationship components.
The behavioral aspect is about control. Who assumes responsibility for the training and specific direction of the work? Does the worker have to work during set hours, at a set location, on specific equipment? If all of these factors are controlled by the employer, there’s a good chance that the worker is an employee.
The financial aspect is about the worker’s control over their profit or loss on the job. Independent contractors are more likely to work for a flat fee or hourly rate determined by their ability. They also control their investment in the job, any unreimbursed expenses, the method of payment, and have freedom to pursue business opportunities outside of the employer’s company. The more of these factors which fall under the employer’s control, rather than the worker’s control, the more likely it is the worker is actually an employee.
The relationship component is all about how you and your worker have defined your agreement, in addition to a few extra factors. The relevant criteria include written contracts, employee benefits, and types of services that the worker is required to provide.
The U.S. Department of labor evaluates “economic realities” including
- How much the work is controlled by the employer
- Who invests in the equipment and facilities where the job is performed
- The extent that the worker can control their own profit or loss on a job
- How much control the worker has on how a job is done and their power to make entrepreneurial decisions
- The permanence of the job and whether or not it is comparable to the work of employees in the company.
This article can help you decide what to call your business relationship. Sometimes, however, an engagement can be right on the blurry line in between the two. In this case, either calling a lawyer to review it can be helpful, or making changes to your relationship to make it more obvious that you are in an independent contractor engagement can be a good move.
If you can’t move further towards an independent contractor relationship, then perhaps it’s time to bite the bullet and make your worker an employee of the company. If there is a doubt, it may be best to just hire the worker and call them an employee. Although there will be additional costs in the area of employer social security, medicare, and unemployment taxes, you will avoid the steep penalties of getting the distinction wrong in the eyes of the IRS.