Employee or Independent Contractor? – How to Classify Correctly

When hiring a new employee, an employer has two choices; he can either hire him as an independent contractor or as an employee. There are pros and cons to either choice and there are strict rules governing the decision. While using an independent contractor, a company doesn’t have to worry about renting a large office, buying office supplies, paying payroll taxes, offering benefit packages, etc. However, the employer’s gain can be the employee’s loss, and so to be fair, there are legal standards of classification.

Life as an independent contractor

The independent contractor, or IC, might perform work on an occasional basis or his daily work hours may be irregular. He may do his job outside of the office. He probably requires little to no direction from the boss and may do much of his work alone. The work that the IC does is specialized, i.e. he is not a catch basin for odd jobs, and others around the office probably don’t know how to do his job.

Examples of independent contractors include writers for the occasional article a company needs, an electrician for a construction company, a website designer for a small business. These people can be hired occasionally or on a regular basis but only for their special work. For example, the employer may have his favorite electrician that he uses on every job, or a company may use the same web designer for all future updates to their website, but the work is sporadic and the employee generally has his hands dipped in a number of different companies.

Depending on the situation, the relationship between the boss and the IC can be strong but might be the only social connection to the company. If this is the case, the IC will probably have a sense of dedication to that person and, transitively, to the company, but more often than not, independent contractors do not feel a sense of loyalty to the company that they work for. The IC works hard in order to uphold his independent reputation rather than to see the company succeed. The IC does not receive added incentive and they don’t typically experience the bond that grows out of conversations at the water cooler and from working as a team. In the face of crisis within the company, the independent contractor will usually be looking for his next assignment.

If the independent contractor is correctly classified the loss of the IC shouldn’t cause great problems; the work he does is not integral to the success of the company but rather is auxiliary work that can be continued by anyone with the proper skill set. Problems arise when the employee works amongst the other employees, doing similar, integral work, on a daily basis. He might be unfairly compensated or alienated due to his misclassification.

Laws protect employees

The difference between an employee and an IC are laid out by the Fair Labor Standards Act, but they are ambiguous and often need to be interpreted on a case by case basis. Employees are easy to identify; they are on a company’s payroll, but independent contractors are often misclassified.

The differences between them have been laid down by common law principles and are evaluated based on those principles on an individual basis. Some of the criteria that the courts have used in the past to classify independent contractors include whether the worker:

  • does work that is temporary. An IC may be hired again and again but is not hired on permanently.
  • supplies his own materials and tools
  • controls the hours of his employment
  • does not receive a steady paycheck
  • does work that is not integral to the functioning of the company
  • defines the work that needs to be done and how it will be accomplished
  • does not gain a large portion of his salary from one company

If the IRS gets a hold of you…

If you have misclassified your employee, and your employee isn’t happy about it, you can end up with a lawsuit. But even if you have a good relationship with your misclassified IC, you aren’t necessarily in the clear. The IRS does recognize these misclasifications and will seek compensation. They don’t want to lose their payroll taxes any more than your employee wants to lose employment benefits. As soon as the IRS figures it out, you’ll have to pay back taxes for all those misclassified hours including FICA and federal unemployment tax. Hiring on an employee as an IC might save you a few bucks in the short run but overall you will be faced with back taxes, lawsuits, as well as disloyal, disgruntled employees.

Timesheets.com users can now classify employees in order to prepare for taxes. There is a new option on an employee’s settings page to classify the employee as employee or IC. At the end of the year, a custom report will determine their 1099.

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