Hiring independent contractors can offer flexibility and cost savings, but misclassifying them as independent contractors when they should be employees can lead to significant legal and financial consequences.
This is one of the more common questions we get from small business owners, and we have compiled some of the most important considerations below:
Control
- Do you dictate the worker’s schedule and hours of operation?
- Employees typically have set schedules and work hours determined by the employer while independent contractors typically set their own schedule.
- Do you provide detailed instructions on how to perform the work?
- Micromanaging tasks and dictating specific methods suggests an employer-employee relationship, but setting standards and expecting contractors to meet them can achieve the same goals without crossing the line.
- Do you have the right to discipline or terminate the worker?
- The ability to control employment conditions strengthens the case for employment. In an independent contractor agreement, your only recourse is to terminate the contract for breach or refuse to renew it after expiration.
- Do you require the worker to be physically present at your workplace?
- While some independent contractors may work on-site, mandatory presence on set days of the week for set number of hours per day suggests control by the employer.
Financial Dependence
- Do you pay the worker a fixed hourly or weekly wage?
- Independent contractors are typically paid by project or task, not a set rate.
- Do you reimburse the worker for business expenses?
- Employers often cover expenses like equipment or travel, while independent contractors bake predictable costs into the project fee.
- Do you deduct taxes from the worker’s pay?
- Employers withhold taxes from employee wages, while independent contractors receive a 1099 form and are responsible for self-reporting taxes.
Integration
- Is their work essential to your core business operations?
- If the worker’s role is integral to your daily functioning, they are more likely to be considered an employee. However, independent contractors may be used to supplement these integral functions if they have unique talents or capabilities no present within your employee workforce.
- Do you provide the worker with equipment and tools?
- While some independent contractors may use company equipment, providing all necessary tools suggests an employer-employee relationship.
- Do you offer the worker benefits like health insurance or paid time off?
- Benefits are typically offered to employees, not independent contractors.
Consequences of Misclassification
Misclassifying employees as independent contractors can lead to:
- Back taxes and penalties: The IRS and states can impose significant fines for misclassification, including unpaid payroll taxes and employee benefits.
- Labor law violations: Minimum wage, overtime, and other labor laws may apply to misclassified employees.
- Unemployment insurance claims: Misclassified workers may be eligible for unemployment benefits.
- Workforce compensation claims: Injured workers may be entitled to workers’ compensation if misclassified.
Seeking Clarity
If you’re unsure about an individual’s worker status, consult with an employment lawyer or tax professional. They can analyze your specific situation and provide guidance to ensure proper classification.
Remember, correctly classifying workers is crucial for avoiding legal and financial repercussions. By carefully considering the factors outlined in this checklist, you can minimize the risk of misclassification and ensure a compliant and ethical working environment.
