Employee or Independent Contractor?

Many companies contract with independent contractors instead of hiring employees to perform certain services. Using independent contractors gives a company greater flexibility in meeting its needs with temporary human resources and usually results in shorter-term commitments and less cost to the company.

Trouble can arise when employers try to turn employees into independent contractors, often to achieve apparent cost savings.  Misclassifying an employee as an independent contractor exposes your company to potentially significant liabilities under wage, unemployment, worker’s compensation, discrimination and other employee protection laws, as well as tort law.  In addition, your company may be liable for withholding and other employment-related taxes, as employers do not withhold federal, state, and local income taxes from payments made to independent contractors and do not have to make contributions to Social Security, unemployment insurance, workers’ compensation, or health insurance.  Government agencies actively pursue and penalize those who misclassify.

Unfortunately, there is no easy answer to the employee versus independent contractor classification question.  There are different tests applied by different governing bodies, the tests change over time, and getting it right for tax purposes may not necessarily get it right for employment discrimination or other purposes.  However, understanding the basics can help get it right in most cases.

  • An “employee” is generally an individual who performs services for a single employer and is financially dependent on the employer for his or her livelihood. The employer controls what work will be done and how it will be done, even if that control is not exercised and she is given freedom of action. The employee routinely and for an indefinite period of time performs services for the employer that are a key aspect and activity of the regular business of the company.  The company controls the financial aspects of the job, such as pay, benefits, etc.
  • An “independent contractor,” on the other hand, is generally someone in an independent business through which he or she offers his or her services in the market at large. Usually, this person is contracted by numerous companies to perform a specific project or service for a defined short-term period of time. She controls the work to be done and how it will be done in order to reach a result requested by the company. In contrast to employees, true independent contractors generally have greater discretion as to how to meet their customer’s need and are primarily responsible for supplying the talents, experience and tools necessary to complete the job. Finally, and perhaps most importantly, an independent contractor is not financially dependent on the company for which she is performing a particular service, but rather has the risk of profit and loss.
  • Regardless of which “test” is used, it is critical to consider an employer’s overall relationship with and control over the worker, irrespective of the person’s title. In order to avoid the pitfalls to which many employers fall prey, it is important to have clear written agreements and company policies with regard to independent contractors. And these agreements and policies must be reviewed regularly to ensure they keep up with an ever-changing landscape. By following these practices, employers can drastically reduce, if not eliminate, liability for improperly classifying what are really employees as independent contractors, regardless of how the worker is sourced.

A good example of an independent contractor is a computer service consultant operated as a stand-alone business.  The firm holds itself out to the public and contracts with numerous companies, including yours, probably on an annual basis. If something goes wrong with your computer system, you call the consultant, describe the problem and ask them to fix it.  You likely are not at the top of the list and you are told when they can be there to help.  Upon arrival, the technician brings everything she needs to diagnose and fix the problem and decides exactly how to do so.  You receive an invoice that you pay.  Beyond that you have no responsibility for any aspect of the consulting firm’s business, whether it be who they hire, how or where they do their work, how or where they source their parts, or whether the business succeeds or not.

Contrast the computer consultant with a technician employed in the IT department of your company.  The technician comes to work and is there every day from 8 am to 5 pm, is told what to do and how to do it, has all of her tools and equipment provided by the Company, gets periodic reviews of the details of his work, receives training at the company’s expense, is paid a set amount by your company every two weeks, and receives employee benefits.  If the CEO has a problem with his desktop, the technician is on it within minutes regardless of what else is on his plate.  The technician is an employee.

Realities: (1) the determination of whether an individual is an employee or an independent contractor depends on the specific facts in each case and the laws applicable to the company, and can be very subjective; (2)  if a worker who is treated as an independent contractor is in fact an employee, then wage, unemployment, worker’s compensation, discrimination and other employee protection laws, as well as tort law, are applicable to that person; and (3) failure to properly classify an employee as such can result in significant liabilities to the company, including tax obligations and penalties from federal, state and local tax authorities.

At McIlnay Button Law, a full-service business law firm, we can help you navigate through the complexities of properly classifying your workers and ensuring your contracts, policies and business practices protect your company from potential liability. Please contact us at 262-421-8060 or use the contact form.