Independent Contractors vs. Employees

Understanding whether an individual is an independent contractor or an employee is key to helping the organization comply with employment and labor laws that affect its businesses.

Many supervisors and managers are under the misconception that if someone is hired as an independent contractor that there is no employment law liability to the company. Unfortunately, that’s not true and it’s important for each hiring manager to understand the company’s obligations depending on the type of relationship it has.

The U.S. Department of Labor defines employees as those who are “suffered or permitted to work.” These are individuals for whom the company fully controls the job duties, assignments, assessments of performance, etc. Employment may be temporary in nature for a specific period of time or for a specific project or it may be for an indefinite period. These individuals are on the company’s payroll and are eligible for various benefits provided by the organization.

Independent contractors are those individuals who are in business for themselves and are generally utilized to perform a specific job where it makes economic sense to outsource that function rather than hire an employee to perform it. Because this is one of the most hotly contested and litigated areas for employers, it’s important to closely review this relationship.

Independent contractors are defined by many employment laws. However, most organizations look to three primary laws to define what characterizes an independent contractor. The laws that we typically look at include the Internal Revenue Code, which sets the “gold standard” for defining an independent contractor, the Fair Labor Standards Act, and state workers’ compensation laws.

Here are some of the primary characteristics that define an independent contractor:

  • They are in business to offer services to the community;
  • They can suffer a profit or a loss;
  • They typically provide their own equipment;
  • They controls how the job is accomplished (the employer is only concerned with the outcome); and
  • The permanency of the relationship with the employer is also considered.

Regardless of what law you look to in order to define an independent contractor, they generally all boil down to the nature and degree of control by the employer. If the individual retains control of the job, they typically can be regarded as an independent contractor; however, if the employer directs the work, tells the individual how it should be done, establishes hours of work, etc., likely the company will be the entity controlling the job and the relationship will be regarded as an employer/employee relationship rather than that of a contractor.

Misclassifying an employee as an independent contractor can greatly affect the company’s bottom line. Here are just some of the things the company can be responsible for:

  • Taxes, including penalties and interest, because we didn’t properly deduct and pay payroll taxes for the misclassified individual.
  • Back pay and front pay to individuals may be due to those who were not properly paid as required under the Fair Labor Standards Act. Employers can also be responsible for penalties related to improper recordkeeping, including lack records for actual time worked.
  • Attorneys’ fees and litigation costs – and not just for the company’s attorneys’ fees. The employer could also be responsible for the attorneys’ fees for the individual.
  • Workers’ compensation. Workers’ compensation carriers are cracking down on this and in some cases are requesting affidavits demonstrating the individuals that have been classified as independent contractors do in fact meet their criteria for being an independent contractor. Improper classification could be regarded as fraudulent by the insurer and the organization potentially could lose coverage.

Some of the things that HR looks for to determine that someone is an independent contractor and NOT an employee include:

  • Contract for services
  • Ability of the individual to produce a business license or some other proof that they are set up in business;
  • Proof of general liability insurance; and
  • Proof of workers’ compensation coverage or a certificate of exemption.

Here are some useful links to help employers assess independent contractor status:

Other states have their own definition of employees and independent contractors and you are encouraged to access your state’s statutes to review that definition.

It is expected that misclassification of the employment relationship will be closely scrutinized by the Department of Labor and the Internal Revenue Service in the near future. It’s important for all employers to review the status of those currently classified as independent contractors to ensure they meet all of the criteria before these agencies begin their scrutiny of these employment relationships.

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