Understand the Difference Between Independent Contractor and Employee
Updated: January 27, 2020
The independent contractor versus employee classification conundrum frequently arises for small business owners and nonprofits. This is especially true when the worker will work “part-time,” “causally”, or intermittent hours. Unfortunately, the difference between the two classifications is not always easy to determine and the consequences of misclassification can be severe.
In our current “gig” economy, businesses are pressured to classify workers as contractors while the workers are pressing for the benefits of employee status. It is ever-important to keep in touch with your legal counsel and regularly examine how you classify your workers.
Internal Revenue Services guidance
Internal Revenue Service Publication 1779 identifies three categories of evidence it considers in classifying workers. These are:
- behavioral control (the extent to which you control or direct how the work is accomplished)
- financial control (relating to how the worker is paid and what expenses the worker must absorb)
- type of relationship (relating to the written agreements between the parties, the duration of the relationship, eligibility for employee benefits)
Though helpful, this multi-factor test often does not result in absolute certainty because often the worker only meets some of the control/relationship tests.
It is very important to note that agreement between the business and the worker does not control. It is not uncommon for an employee to “quit” and then be hired as an independent contractor doing essentially the same job with little else to merit independent contractor classification. This is a dangerous position for businesses given the financial consequences of misclassification (see below).
Independent Contractor v. Employee
Independent Contractor. In general, independent contractors have more control (independence) in determining when and how to do the job. Given reasonable parameters, these individuals can determine when and how to do their job, will provide their own tools, and will often (but not always) have many clients, not just you.
For small businesses and nonprofits, these positions are often (but not always) your “as-needed” or few-time-per-year services, such as accountant/auditor, attorney, lawn maintenance, or vehicle fleet maintenance. In other words, items you outsource to another business, be it a sole proprietor or an entity with many employees.
Employee. Generally, the business maintains significant control over the employee. For example, assigning the days worked, determining how the work is accomplished, providing the tools used, and providing the physical space used. The employee is paid on a consistent basis (usually weekly or biweekly). The employee is often entitled to benefits, such as vacation time, sick pay, holiday pay, participation in retirement plans, etc.). The employer deducts payroll taxes and other withholdings from the paycheck.
The Consequences of Improper Classification
The failure to correctly classify a worker as an independent contractor or an employee can have significant financial consequences to both parties. In addition to paying retrospective federal and state employment taxes (plus interest and penalties), you may also face penalties from the US Department of Labor, obligations regarding retrospective employee benefits, and possible audits under the Affordable Care Act.
What about State law?
Here, the inquiry becomes even more complicated. The debate over independent contractors and employees is hot right now, especially with the gig economy. Many states are taking matters into their own hands and passing new laws that may differ substantially from long-standing positions. In addition, the National Labor Relations Board (NLRB) cannot find hold a consistent position on this topic. In short, this debate is something attorney employers must continually keep monitor to ensure compliance.
Here, in Pennsylvania, our federal court and state court cannot arrive at the same conclusion. In cases involving Uber drivers, the federal court ruled the drivers were contractors while the state court ruled (in a different, but similar case) they were employees.
California, in particular, has greatly confused the independent contractor – employee classification with a combination of case law (made by court decisions) and state law (made by elected representatives). Many other states are following suit and attempting to legislate who is an employee or a contractor (usually increasing protections for the gig workers rather than benefiting the employers). Thus, when in doubt, consult an attorney knowledgeable in this area. The small cost of the advice outweighs the potential penalties of improper classification.