When to Classify a Worker as an Independent Contractor

By MBO Partners | May 3, 2023

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Key Points

To remain compliant and minimize the risk of misclassification, it’s important to have a general awareness of the differences between independent contractors and employees.

Engage independent contractors for defined projects and hire an employee for ongoing business needs.

Consider independent contractors when you need specialized skills and hire an employee to conduct routine work for your business.

Today’s workforce includes full-time employees, temporary workers to fill seasonal or short-term needs, and contingent workers such as freelancers, independent contractors, or consultants.

Businesses benefit from this diversity of workers. Workforce diversity gives companies have more workforce flexibility, access to specialized skills on-demand, and the ability to form ready-made teams when a project need arises. However, it is important that employers correctly classify their workers to comply with local, state, and federal laws.

What is the Difference Between an Independent Contractor and an Employee?

Independent contractor: A legal term for workers who are not considered to be full-time employees under the law. Independent contractors may refer to themselves as freelancers, consultants, self-employed professionals, side-giggers, etc. The big difference between independent contractors and your typical W-2 employee is that independent contractors are their own business entity. They pay their own taxes, provide their own benefits, and submit invoices for work completed. 

Independent contractors provide specialized knowledge or skills to a client project or task. They are responsible for how, when, and where they complete the work outlined in their contract. An employee, on the other hand, is typically guided by a manager, and receives some level of training for their job. 

When engaging independent contractors, it is important to have a general awareness of the differences between independent contractors and employees to remain compliant and minimize the risk of misclassification.

There are many different laws, tests, and guidance documents that govern whether a worker should be classified as an employee or an independent contractor. These nuances can quickly become confusing, and sometimes even contradictory, for businesses.

Learn more: Worker Classification Tests: DOL, IRS, State Tests for Classifying Workers

Worker Classification: Three Key Points to Consider

1. How much control do you have over the worker?

Employees work for a single employer. That employer can determine what work the employee does, how they do it, and when they do it. For example, a manager has a certain degree of control over the hours, location, and type of work an employee is responsible for. With independent contractors, it is important to be highly aware of this degree of control.

IRS classification of independent contractors, on the other hand is a bit different. Independent contractors are their own business entity and can choose when, where, and how they complete the work they are contracted for.

Aside from behavioral control—dictating how and when work is done—employers must also be aware of financial control. Unlike employees, it is common for independent contractors to be reimbursed for certain expenses they incur for their project work. Independent contractors also tend to be paid a flat fee for their work rather than a regular wage in exchange for working a certain period of time, like an employee.

2. What type of work are you hiring the worker to complete?

As a general rule of thumb, it is best to engage independent contractors for defined projects and hire an employee for ongoing business needs. A project is something that has a specific start and end date, defined success metrics, and agreed-upon deliverables. An ongoing business need focuses on the core goals of your business.

If employees are already performing the same work you want to engage an independent contractor to do, this is a red flag. In most cases, independent contractors should be providing skills or experience that is not a core part of your business.

3. Do you need specialized expertise or just another helping hand?

Independent contractors are experts in their field of work and have built their business around their skillset. When deciding whether to engage independent talent or hire an employee, consider whether the work you need done requires a specialized set of skills. If your project is more generalized work that existing employees have the skills to complete, the work should be assigned to an internal employee or a new hire if your workforce is at capacity.

Keep in mind that independent contractors are generally responsible for providing any tools or materials they need to complete their work and they should not require additional training to start a project. When hiring an employee, on the other hand, it is expected that they will receive some sort of training for their job and are given a place and tools to do their work.

Check out: Should I Hire a 1099 Contractor or W2 Employee? 6 Questions to Ask

The information provided in the MBO Blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO Blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.

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