While you’re growing your company, you want to bring on help – to handle development, sales, product, HR, or any of the other million things you want to offload. It’s important to understand the difference between bringing on an Independent Contractor, vs. an Employee.
There are several important legal, tax, and human resources implications when it comes to Independent Contractors vs. Employees. This doesn’t just involve your company – the Department of Labor, the Internal Revenue Service, state authorities, and local authorities also have rules around this.
This post will give you a high level overview of the difference between the two, and what could happen if you misclassify one for the other.
What is an Independent Contractor?
An Independent Contractor contracts with your company to provide services in exchange for compensation. They do not work regularly for any single company (besides their own), and generally meet the following criteria:
- They are not protected by most federal, state, or local laws intended to protect employees,
- They are responsible for paying their income, social security, and medicare taxes,
- They retain economic independence in terms of withholdings, etc.,
- They retain control over the method and manner of work – no set hours, no specific way to do things, etc.,
- Their engagement with your company is for a pre-determined term – the amount of time required to perform an identified service or task,
- They charge fees for their services,
- They do not get benefits from your company,
- They are free to offer their services to the public, and perform work for other clients (no exclusivity to you).
- Per their title – they work independently.
If you’re hiring an Independent Contractor, you have the right to control only the end result of the project, and not how the independent contractor accomplishes it. From a tax standpoint, you are to issue the independent contractor a Form 1099-MISC for income-reporting purposes.
What is an Employee?
An employee is hired full-time, or part-time, by your company. Your company has significant oversight into how they do their work – including the right to control the method and manner of their work. Employees generally meet the following criteria:
- They are protected by applicable federal, state, and local employment laws,
- They are paid wages (which may include overtime) and company sponsored benefits, if you offer them (such as health insurance, retirement plans, stock options, paid vacations, sick days, life insurance, disability insurance, fringe benefits, etc.)
- They are employed for a continuous period of time, and have required tasks,
- They pay the full amount of their income taxes and a portion of their social security, and Medicare taxes, that your company/HR provider is obligated to withhold from their wages,
- They are not economically dependent on your company.
What can happen if I misclassify one for the other?
As stated above, the Department of Labor and the Internal Revenue Service can get involved if you misclassify an Independent Contractor for an Employee, or vice versa. Both departments can conduct independent contractor audits, and apply their own tests (based on the Fair Labor Standards Act (FLSA) called the Economic Realities Test, and the Department of Labor Standards.
If you do misclassify, you can be liable for:
- Tax and insurance obligations,
- Disability payments and workers’ compensation,
- Social Security and Medicare taxes,
- Paying overtime to the misclassified individual,
- Employee benefits – including stock options, retirement benefits, plan coverage, etc.
- Liquidated damages and Civil monetary penalties if legal action is pursued.
Let us Help.
This article is just a high level overview of an Independent Contractor vs. an Employee, and what can happen if you misclassify one for the other. There are many nuances involved when dealing with employment law, including understanding the Economic Realities Test, and the DOL standards.
Kader Law can connect you with experienced employment attorneys, and help you understand how to approach hiring Independent Contractors vs. Employees through our Outside General Counsel offering. If you’re interested in connecting, feel free to contact us.
This post is not legal advice, and does not establish any attorney client privilege between Law Office of K.S. Kader, PLLC and you, the reader.