DOL Clarifies Definition of Independent Contractor

Independent contractor vs employee

While employees are allowed greater job security and are aided by their company in paying taxes, employees generally do not have the freedom to work their own hours, have less room for negotiation, and often over-extend their original job descriptions. Whichever path you choose, be sure that you know the tax implications involved in your decision. “I usually see it where someone wants to save as much money as possible, and [the company] works people 50, 60, 70 hours a week and won’t pay overtime because they’ve misclassified [the people],” says Miklas. Not withholding taxes and benefits (or incorrectly withholding them) doesn’t just put an undue burden on employees and contractors. If you “misclassify” a worker and don’t correctly withhold or pay the required amounts, the IRS may flag your business and come after any money owed.

The U.S. Supreme Court has repeatedly held there is no single rule or test for determining whether someone is an independent contractor (1099-NEC) or an employee (W-2) for the purposes of the Fair Labor Standards Act (FLSA). There’s more than one test to determine if an independent contractor is actually an employee, and getting it wrong can cost you more than back pay—it can cost you your freedom. You need to arrange a Form W-9 and file Form 1099-MISC for each independent contractor you pay $600 to or more during the tax year.

  • The IRS no longer uses this test, but it can still shed light on how they think.
  • You need to arrange a Form W-9 and file Form 1099-MISC for each independent contractor you pay $600 to or more during the tax year.
  • There are many advantages to being an independent contractor, like being able to establish your own schedule and knowing exactly what work you will be performing as outlined in your contract.
  • Of course, the crucial issue is whether or not the people doing work for you are employees or self-employed contractors.
  • If you’re genuinely not sure how to classify a worker, you can file Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) to request a formal determination from the IRS on worker classification.

Learn how to evaluate these variables and determine whether you should hire an employee or a contractor. Independent contractors are business owners, meaning they set their fees and can have more than one client at the same time. When you interfere with the financial side of an independent contractor’s business, you’re crossing the independent contractor-employee line. Businesses bring on independent contractors to complete projects that require capacity and expertise not found in their workforce.

Employee vs. Contractor: Which Should You Hire?

Most of the time, it’s easy to discern an independent contractor from an employee. However, sometimes the nature of a worker’s role lies in a gray area between the two classifications. More than one government agency has a test to define what an independent contractor is.

  • If you classify an employee as an independent contractor and you have no reasonable basis for doing so, then you may be held liable for employment taxes for that worker (the relief provisions, discussed below, will not apply).
  • Behavioral Control covers facts that show if the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means.
  • There are many ways in-house counsel can demonstrate their value to the company.
  • Behavioral control is all about how much influence a business has over the services the worker provides.

You should consider all evidence of the degree of control and independence in this relationship. The facts that provide this evidence fall into three categories – Behavioral Control, Financial Control, and Relationship of the Parties. Accurate classification of workers as either independent contractors or employees is imperative in order to maintain compliance with labor laws and circumvent possible legal and financial penalties. Each state also has tests to determine a person’s status under workers’ compensation and unemployment insurance laws. The economic realities test used in most states makes it harder to classify a worker as an independent contractor because, in addition to the degree of control test, it considers the degree the worker is economically dependent upon the business. The most common way companies get into trouble with misclassification is by not paying overtime.

Tax & Accounting

They tend to get paid for projects, they worry about their own taxes, and work when and where they want. For tax purposes, the IRS considers them to be self-employed, which means they have to pay self-employment tax. It is important to be productive and earn money in our society; any successful person knows that and, in addition, should understand their obligation to obey the law. This is the story of a gifted young man in too much of a hurry “to make it” and not interested in following sound advice when it comes to independent contractors vs. employees. The IRS and many states have adopted common law principles to define an independent contractor.

With the new administration’s focus on making it difficult to be classified as an independent contractor, “there are going to be more challenges,” Miklas warns. “Now’s the time companies should be auditing [themselves] and making sure these people really are independent contractors.” As a business owner, you need to file different tax forms depending on whether you hire an employee or an independent contractor.

Independent contractor vs employee

Each has its own angle, which means that each has a slightly different focus. That said, many test factors coincide, while others contradict each other. If you make a good faith effort to clear as many factors as possible, you’ll be well on your way to classifying workers correctly. Just because someone works remotely, signs an independent contractor agreement, pays for their own office supplies and receives a 1099 form doesn’t necessarily mean they’re an independent contractor. Also remember that misclassifying employees as contractors carries a much higher penalty than misclassifying the other way around. If both options are on the table and you have the budget for it, it’s always safer from a classification standpoint to simply hire an employee.

Misclassification of Employees

In today’s job market, businesses and job seekers alike are no longer relying on a traditional 9 to 5 work life. Instead, they’ve adopted a more flexible approach to employment through short-term work arrangements. Independent contractors generally take on a measure of financial risk and can incur losses. They often have fixed operating costs relating to operating a workspace or hiring helpers or assistants.

Make sure you know exactly what you require from a worker and how much you can invest in them before hiring anyone. If you need a full-time worker to help run the business and are willing to spend the time and resources, hire an employee. Partner with a contractor if you can offer a competitive hourly rate and need flexibility but can’t offer benefits. Either way, clearly define expectations beforehand and treat both kinds of workers with the respect they deserve.

This is because misclassification leaves them ineligible for unemployment insurance or workers’ compensation benefits. Besides potential problems with the government, misclassification can also lead to issues with the misclassified workers themselves. Workers that believe they have been misclassified may sue their employers seeking back pay, unpaid overtime, and other benefits they have the right to.

The earnings of a person who is working as an independent contractor are subject to self-employment tax. To find out what your tax obligations are, visit the Self-Employed Individuals Tax Center. Hiring employees can be more expensive than hiring contractors due to the cost of training, benefit packages, and expectation of raises and bonuses. But employees are better equipped to take on additional responsibilities and have more flexibility to help your business succeed.

Classifying workers as employees or independent contractors is a tricky business. After all, the rules change as often as the administrations in Washington, D.C. If you have a reasonable basis for not treating a worker as an employee, then you may be relieved from having to pay employment taxes for that worker. To get this relief, you must file all required federal information returns on a basis consistent with your treatment of the worker. You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977. See Publication 1976, Section 530 Employment Tax Relief RequirementsPDF, for more information.

Additionally, you must also pay the matching employer portion of social security and Medicare taxes as well as pay unemployment tax on wages paid to an employee. Generally, you do not have to withhold or pay any taxes on payments to independent contractors. Independent contractor vs employee For federal employment tax purposes, the usual common law rules are applicable to determine if a worker is an independent contractor or an employee. Under the common law, you must examine the relationship between the worker and the business.

Legal data & document management

Business owners have more control over where, when, and how their employees perform tasks. If you desire more worker supervision and project oversight, hire employees. Contractors can fill your business needs for more flexible, low-supervision projects. Depending on your business needs and other factors like taxes, benefits, and worker supervision, one option may make more sense than the other.

The misclassification of a worker as a self-employed contractor rather than an employee can lead to back taxes and penalties for businesses. In fact, nearly 70% of all federal tax revenue paid to the IRS is represented by federal employment withholding taxes. Both the Department of Labor (DOL) and similar state-level organizations help to ensure that workers are properly classified by their employers, yet improper employee classification still leads to dozens of class action lawsuits per year. The Voluntary Classification Settlement Program is an optional program that provides businesses with an opportunity to reclassify their workers as employees for future employment tax purposes.

While an “independent contractor” is different from a standard employee, the exact definition of your role is not set in stone. And the rule noted a SHRM survey that found 49 percent of external workers chose that work arrangement for the ability to set their own hours. Independent contractors and freelancers do not personally have to carry out the work for which they have been hired. Tools and equipment are usually provided by the payer, who is also responsible for repair, maintenance and insurance costs.