Independent Contractors vs. Employees
As a business owner or manager, it’s important to be familiar with all laws surrounding business practices, especially as they pertain to employment.
Independent contractors are appealing to small businesses for a variety of reasons. Using the services of independent contractors may save the employer taxes and from offering other (sometimes expensive) employee benefits.
However, there are consequences and legal implications associated with classifying someone as an independent contractor when he or she is (according to law) an employee of your organization.
It is crucial to understand the difference.
Independent contractors offer services to the general public in independent trades, businesses or professions. In many circumstances, doctors, dentists, veterinarians, lawyers, accountants, contractors, freelancers, designers and even auctioneers may be classified as independent contractors. In general, if the individual has the right to direct his or her schedule, the type of work that will be done and the end result of that work, he or she can possibly be classified as an independent contractor. Employers are not required to withhold or pay any taxes on payments to independent contractors. Individuals who are legally classified as independent contractors are considered self employed, and as such are subject to Self-Employment Taxes.
An individual is considered an employee if an employer-employee relationship of any sort exists. As an employer, if you control what services will be done and how they will be done, the worker would typically be considered an employee. In the case of employees, employers are obligated to withhold income taxes, withhold and pay Social Security and Medicare taxes and pay unemployment taxes on wages paid.
Three questions to consider when determining an individual’s status as an employee or independent contractor are as follows (according to the IRS):
1. Behavioral: Do you (as the employer) control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by you or your company (examples include how the worker is paid, whether expenses are reimbursed and who provides the tools/supplies)?
3. Relationship Type: Do written contracts or employee-type benefits (i.e. pension plan, insurance, vacation pay, etc.) exist? Will the relationship continue long-term? Is the work performed by the individual a key aspect of your business?
Taking a look at these classifications may give you a better idea of how to classify an individual with whom you have a business relationship.
To further distinguish employees from independent contractors, the IRS created common law principles to define independent contractors. They focus on the level of control an employer has over the service being provided. Employee status is obvious if the individual is on the employer’s payroll and receives a steady paycheck. But, factors defining independent contractors include:
• If the individual supplies his or her own equipment, materials and tools,
• If all necessary materials are not supplied by the employer,
• If the individual can be discharged at anytime and can choose whether or not to come to work without the fear of losing employment,
• If the worker controls the hours of employment thus indicating they are acting as an independent contractor, and
• If the work is temporary or on an as-needed basis.
These points should be considered when determining employment status.
It’s crucial to make the correct designation as it pertains to employer-worker relationships. There are harsh penalties for incorrectly defining an employee as an independent contractor. In this situation, employers may be held liable for past taxes (including FICA and federal unemployment taxes). In Pennsylvania, knowingly misclassifying an employee as an independent contractor may be considered a criminal offense in certain industries (like the construction industry).
As an employer, it is critical to correctly distinguish employees from independent contractors. The future of your business may depend on it.
Have questions on the status of your workers? Still unsure of the correct classification? Contact Michael Hynum of the legal team at Hynum Law.
Hynum Law's employment lawyers are able to answer questions and provide guidance. We look forward to working with you.