The main difference between an employee and an independent contractor is the control of the work process. In an independent contractor relationship, the hiring party controls only the end result and the independent contractor controls how the work will be performed to achieve this result. By contrast, in an employer-employee relationship the employer controls both the end result and how the work will be performed. Whether a worker is properly considered an employee or an independent contractor is not always an easy determination. A written agreement will not be controlling if the designation of the worker in the agreement is not reflective of the true nature of the relationship. Some factors suggesting employee:
- Employer sets work hours for worker
- Employer provides training for worker
- Worker has long-term relationship with employer
- Worker wears a uniform supplied by employer
Some factors suggesting independent contractor:
- Work is performed by an entity and not an individual
- Worker performs similar job for other customers
- Worker has special skills or licensing
- Worker supplies his/her own tools
Employers may be motivated to misclassify employees as independent contractors. The primary reason employers do this is for the cost savings. The sources of the cost savings are: (1) employers may not be required to provide workers compensation insurance coverage to independent contracts; (2) employers do not pay payroll taxes on compensation paid to independent contractors; and (3) employers do not provide benefits (e.g., health insurance) to independent contractors. In addition, because many labor laws (e.g., Affordable Care Act and Family Medical Leave Act) do not apply to employers with fewer than a threshold number of employees, employers may misclassify workers to avoid the expense of compliance with these laws.
There are significant legal risks associated with the misclassification of employees as independent contractors. A federal or state tax audit that uncovers misclassified workers can lead to the payment of back taxes plus penalties and interest. In addition, some labor laws, such as the Fair Labor Standards Act, impose treble damages in addition to back wages and overtime. The majority of audits are the result of a referral from a state agency when a worker the employer has classified as an independent contractor applies for benefits. The agency’s investigation may suggest misclassification and this may open the door to an IRS and/or state tax audit of not just the worker, but the entire organization.
Choosing the correct worker classification is an individualized decision and should be done only after discussing your specific situation with your lawyer and tax advisor.