Understanding Employee vs. Independent Contractor

June 17, 2024

When deciding to have someone work for you, it’s crucial for businesses to correctly classify them as either an employee or an independent contractor. Misclassification can lead to significant legal and financial consequences, including denying workers minimum wage, overtime pay, and other legal protections. With the recent rise in the number of independent contractors, understanding the distinctions and compliance considerations is more important than ever.

Why Proper Employee Classification Matters

Misclassification of workers can lead to legal issues for businesses and deny workers their rightful benefits and protections. Recent updates in the U.S. Department of Labor’s guidelines aim to reduce these risks by providing a consistent approach to classifying workers. Employers must ensure compliance with various federal, state, and local laws to avoid penalties.

How do you correctly classify workers? IRS Common Law Rules for Classification

To determine whether a worker is an employee or an independent contractor for federal tax purposes, the IRS uses three Common Law Rules:

  1. Behavioral Control:

  • Employees: The business controls what the worker does and how they do their job. Employees work specific hours, follow set procedures, and use company-provided tools.
  • Independent Contractors: They decide how to complete their tasks, set their own hours, and use their own tools.

  1. Financial Control

  • Employees: The business controls financial aspects like pay, reimbursement, and provides tools/supplies. Employees receive regular wages with taxes withheld.
  • Independent Contractors: They manage their own business expenses, invoice for their work, and have a financial stake in their success.

  1. Type of Relationship

  • Employees: They receive benefits such as insurance and paid time off, have an ongoing relationship with the business, and perform key roles integral to the business’s operations.
  • Independent Contractors: They are hired for specific projects or tasks, do not receive employee benefits, and have a more flexible, short-term relationship with the business.

Classification can still be a complex process, requiring careful consideration of all factors.

If you need guidance on how to classify a worker or have any other HR questions, consult The Consonance Group.