Workers can be classified as either an employee or independent contractor. Many employers would prefer classifying all their workers as contractors because it saves them money, but it’s not that simple.
The IRS and the DOL have laws regarding employee classification. Whether to classify a worker as an employee vs contractor is a matter of what type of work the worker does and how it’s done. I’ll show you how to understand this employment relationship so that you can be compliant with the IRS and the FLSA.
Employee vs Contractor: Benefits of Each
Without a doubt, hiring contractors over employees has its perks. Independent contractors take some financial burden off of employers. With contractors, employers don’t have to worry about renting an office space, buying office supplies, paying payroll taxes, offering benefits packages, or paying overtime.
Furthermore, contractors are just an all around easier worker to hire. With contractors, there isn’t a bunch of paperwork that needs to be done. There are no quarterly taxes to file, insurance to setup, etc.
However, the employer’s gain can be the employee’s loss, and that’s why there are laws surrounding this classification.
While there is definitely some money and hassle to be saved by hiring contractors over employees, there are plenty of benefits of hiring employees too. First, contractors usually come at a higher hourly rate since they don’t receive any benefits like health or 401k. Second, employees often have more loyalty to a company, a more solid vision, and attention for their projects. Employees are also more likely to take specific direction from their boss, whereas a contractor might do work their way.
Depending on the situation, the relationship between the employer and the contractor can be strong but might be the only social connection to the company. If this is the case, the contractor will probably have a sense of dedication to that person and, transitively, to the company. More often than not, however, independent contractors do not feel a sense of loyalty to their contracting company.
The main concern of the contractor is to uphold her own independent reputation rather than see the company succeed. The contractor does not receive any added incentives and doesn’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 the next assignment.
However, if the independent contractor is correctly classified, the loss of the contractor 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. So let’s look at how to classify workers correctly.
Difference Between an Employee vs Contractor
Independent contractors and employees are different. Contractors may not differ from employees in all of the following ways but usually many independent contractors find that they:
- Perform work on an occasional basis
- Have irregular working schedules
- Control their hours of employment
- Do their job outside of the office
- Require little to no direction management
- Perform much of their work alone
- Do specialized work
- Supply their own materials and tools
- Do work that is not integral to the functioning of the company
- Define their own work and how it will be done
- Gain income from multiple companies
Examples of work that contractors do include:
- Some types of marketing projects
- Electrician for a construction company
- Website designer for a small business
Employers can hire these contractors 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. This work is sporadic, though, and the employee generally has his hands dipped in a number of different companies.
Workers Protected by the FLSA
It isn’t always easy to tell the difference between an employee vs contractor. The distinction has always been a bit nebulous. However, the Department of Labor came up with the economic realities test which is supposed to help employers figure it out. If it’s still confusing, using California’s ABC test is a sure bet that you’ll be compliant with the FLSA.
You should do your best to classify workers correctly but, ultimately, the IRS or Department of Labor have the final say on the matter.
The IRS Expects Its Cut
The IRS doesn’t want to lose its payroll taxes any more than your employee wants to lose employment benefits. Hence, they look for violators. If they catch you, you’ll have to pay fees and back taxes for all those misclassified hours, including FICA and federal unemployment tax.
Misclassifying an employee as a contractor might save you a few bucks in the short term but it can be costly in the end. Fees, back taxes, lawsuits, and disgruntled employees are not things that will help your company thrive.