When is an Independent Contractor an Employee?
Organizations today have many different approaches to building their workforce. Traditionally, businesses relied on a base of full-time employees, perhaps supplemented by temporary workers to fill seasonal or short-term needs. In recent years, however, companies are increasingly incorporating independent contractors into their talent strategy. And no wonder—independent professionals bring substantial financial benefits, access to in-demand skills in a competitive talent market, and the ability to flexibly staff timely project needs.
Yet there are specific rules and regulations dictate how to properly classify independents. If a company engages someone as an independent contractor, but this person should actually be classified as a full-time employee in the eyes of the IRS or applicable state laws, the company may be at risk for misclassification. Regardless of whether or not misclassification is intentional, it puts companies at risk for owing back taxes, benefits, and penalties to misclassified workers.
Independent Contractors vs. Employees
There are many key differences between independent contractors and employees that are important to understand, especially if your company is considering engaging independent talent. A full-time employee works for a single employer and that employer has say over the work they do and how that work gets done. An employer can control the hours, location, and type of work an employee is responsible for. Employees are also entitled to benefits, which may include health insurance, stock options, or 401(k) matching.
On the other hand, independent contractors are their own business entity. They may perform work for multiple clients, and are free to choose when, where, and how they work. The work they are responsible for is typically outlined in a contract, and they generally provide their own tools, training, and equipment. They are not entitled to company or legal benefits like a full-time employee.
Independent Contractor Misclassification
Unfortunately, correctly classifying workers as either traditional employees, who receive a W-2 Wage and Tax Statement, or independent contractors, who receive form 1099-MISC, Miscellaneous Income, is far from simple. There are many different federal- and state-level tests that provide guidelines for determining whether a worker is an independent contractor, and these tests can contradict one another and can be understood in different ways.
As more companies shift towards using independent talent, interpretation of these laws, tests, and guidance continues to evolve.
In order to avoid the consequences of worker misclassification, it is important to be aware of federal, state, and local government laws surrounding classification, understand how independent contractors differ from employees and treat them accordingly, and to always use a written contract when engaging independents. Even with these provisions in mind, ensuring independent contractors are correctly classified not a straightforward or simple task.
In order to minimize the risk of misclassification, many companies choose to partner with a firm that has experience in helping other organizations compliantly engage independent talent and can indemnify against misclassification and legal risk.
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.