Hiring someone to help your business grow should be a positive step. However, before deciding whether to hire someone as an employee or an independent contractor, it is important to understand that the distinction involves much more than how you pay them.
Worker classification affects taxes, benefits, unemployment obligations, wage-and-hour requirements, and other legal responsibilities. Getting it wrong can create significant problems for a business later.
So, what actually determines whether someone is an employee or an independent contractor?
It Is About the Relationship, Not the Title
One of the biggest misconceptions is that a business can simply decide to classify someone as an independent contractor. Calling a worker a contractor does not necessarily make that person one. The same is true even if the worker signs an agreement stating that they are an independent contractor.
Instead, government agencies and courts may look at how the relationship actually operates. A major consideration is how much control the business has over the worker and the way the work is performed.
How Much Control Does the Business Have?
Employees generally work under greater direction and control from an employer. For example, a business may set an employee’s schedule, provide instructions on how to complete the work, require the employee to follow particular procedures, provide training, and supervise the employee’s day-to-day activities.
An independent contractor generally has more freedom to determine how the work will be accomplished. The business may set the desired result or deadline, but the contractor typically controls the methods used to complete the project. No single factor determines the answer. Consider the entire working relationship.
Who Controls the Business Side of the Work?
Financial independence is another important consideration.
Independent contractors often operate more like separate businesses. They may provide their own equipment, pay their own expenses, advertise their services, work for multiple clients, and have the opportunity to make a profit or experience a loss.
Employees are more commonly paid a regular wage or salary and rely on the employer to provide the tools, equipment, and resources necessary to perform their jobs.
Again, these are indicators, not absolute rules. Every working arrangement is different.
What Does the Relationship Look Like?
The nature and duration of the relationship can also matter.
An employee may have an ongoing relationship with the company and receive benefits, such as paid time off, health insurance, or retirement benefits. The work performed may also be an important part of the company’s regular business operations.
An independent contractor is often hired for a particular project or service and may simultaneously provide similar services to other clients.
A written agreement can help set the parties’ expectations, but it should accurately reflect what happens in practice.
Why Does Classification Matter?
Correct classification matters because businesses have different responsibilities toward employees than toward independent contractors.
Employers generally must withhold applicable taxes from employee wages and pay certain employment taxes. Employees may also be protected by wage and hour laws, unemployment programs, and other workplace protections that may not apply in the same way to independent contractors.
Independent contractors, by contrast, are generally self-employed and responsible for handling their own taxes and many of their own business expenses.
What Happens If a Worker Is Misclassified?
Misclassification can become expensive.
If a worker who should have been treated as an employee was incorrectly classified as an independent contractor, a business may face liability for unpaid employment taxes and other obligations. Depending on the circumstances, additional issues involving wages, benefits, unemployment claims, or penalties may also arise.
Problems often surface when the working relationship ends, a worker files for unemployment benefits, or a government agency reviews the company’s employment practices.
That is why you should address classification when the relationship begins, not after a dispute develops.
A 1099 Does Not Settle the Question
Business owners sometimes assume that issuing a Form 1099 instead of a W-2 automatically establishes someone as an independent contractor. It does not.
Tax forms reflect how the business has classified the worker, but they do not necessarily determine whether that classification is legally correct. The actual relationship between the business and worker remains the important consideration. Employees and independent contractors can both play valuable roles in a business, but they are not interchangeable classifications. Base the decision on the reality of the working relationship, not convenience, tradition, or the title at the top of an agreement.
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