When is an Independent Contractor Really an Employee?

By MBO Partners | July 26, 2022

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Key Points

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.

Independent professionals bring companies substantial financial benefits including access to in-demand skills in a competitive talent market and the ability to flexibly staff timely project needs. 

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. 

What is an Independent Contractor vs. Employee?

These definitions will help you understand how each type of worker is defined:

Employee

A full-time employee works for a single employer and that employer has a 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. 

Independent Contractor

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. 

Up next: Contractors vs Employees: 10 Differences You Need to Know 

What are the differences between Independent Contractors and Employees?

There are many key differences between independent contractors and employees. These differences are important to understand, especially if your company is considering engaging independent talent.  

Today, organizations 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 strategies. And no wonder—independent professionals bring substantial financial benefits including 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 that dictate how to properly classify independents. If you engage someone as an independent contractor, but this person should be classified as a full-time employee in the eyes of the IRS or applicable state laws, your company may be at risk of misclassification. Regardless of whether misclassification is intentional, it puts companies at risk of owing back taxes, benefits, and penalties to misclassified workers. 

Check out: 5 Reasons to Hire Independent Contractors 

Worker Classification

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 
  • Always use a written contract  

Even with these provisions in mind, ensuring independent contractors are correctly classified is not a straightforward or simple task. 

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. 

Check out: Risk management solutions from MBO 

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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