It is important to understand the main differences between an independent contractor vs. an employee when hiring new workers. The classification of a worker has implications for their entitlements, for example health benefits, paid vacation and taxation. Misclassifying workers can have serious financial implications for your business. As a result, you should familiarize yourself with different types of workers, including:
Comparing independent contractors vs. employees will equip your business to improve its hiring process and to comply with the rules and regulations set out by the IRS.
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Employees are sometimes referred to as common law employees and are paid on an hourly, commission or salaried basis. Employees are normally entitled to receive overtime pay. Your business is required to withhold state and federal taxes from your employees’ wages. Federal Insurance Contributions Act (FICA) taxes, which include taxes for Medicare and Social Security must also be withheld from your employees’ pay. Employees must receive a Form W-2, which details the income they have earned during the year.
Typically, an employee can be classified by the amount of control your business has over their work. Where your business is in charge of the details around how tasks are completed, the person doing the work is likely to be an employee. Additionally, if your business buys supplies and has the final say on how payment is handled, it is highly likely that this worker will be classified as an employee.
The following are indications that a worker is an employee:
One of the main differences between independent contractors vs. employees is that independent contractors are free to work for different clients. Independent contractors are also known as contract workers and normally receive pay for every project, as opposed to hourly pay or a salary. They typically work in any location they choose and use their own resources to carry out projects.
If you hire a contract worker, your business does not withhold state, federal or FICA taxes on their pay. Independent contractors are responsible for paying their own self-employment tax.
A worker can be classified as an independent contractor if the following applies:
The IRS does not provide a blanket method of classifying contract workers and employees. Typically, the IRS will make the assumption that a worker is an employee. Each situation will be looked at separately to decide whether a worker should be an independent contractor vs. an employee. However, you can use the following guidelines issued by the IRS to help you to categorize a worker:
If you are having difficulty classifying employees vs. independent contractors, it is always safer to assume that the worker is an employee in relation to the IRS. You should file a Form SS-8 ‘Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding’ if you are unsure about whether someone is a contract worker. You will be notified by the IRS about how the worker should be classified. Form SS-8 can also be submitted to the IRS by your workers.
When you have identified someone as a contract worker, you are required to:
Gig workers are generally considered to be independent contractors and must rely on the terms of a contract if they have a dispute with the company they work with. This is because they are not covered by the Fair Labor Standards Act.
Gig workers, who are also known as on-demand workers are part of the contingent workforce. This classification of worker generally does not have the rights to go to a government agency for assistance in relation to getting their contract enforced. In these circumstances, the contract worker would have to file a lawsuit if they believe your company has breached the contract.
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There have been labor advocates who have tried to reclassify gig workers as employees, ever since the emergence of on-demand work. This is due to the belief that on-demand workers receive no or little protection, while bearing the employer’s costs. In support of this point of view, a state Supreme Court ruling in California in April 2018 found that employers must use a narrower test when deciding how to classify workers. The decision resulted in a mandate for cannabis-delivery workers to be classified as employees. As a result, the indications are that an increasing number of companies may have to classify gig workers as employees.
Uber and other California-based companies may be subject to overtime and minimum-wage laws for gig workers in the future. It is estimated that a shift from the contract worker to the employee model could cost companies an additional 20 to 30%.The Supreme Court ruling has implications for the classification of workers and can make it harder to categorize workers as independent contractors.
The test applied by the Supreme Court in California to determine a worker’s status was much simpler than previous tests. Instead of applying numerous different factors to determine whether someone is an employee, the court used the test of whether the worker performs a job that is part of the usual course of the company’s business. If it is found that a worker can answer yes to this test, they will be considered to be an employee and not a contract worker. Additionally, a company needs to demonstrate that it does not direct the worker and the worker actually operates their business in an independent way.
The independent contractor vs. employee debate continues in relation to on-demand workers. It is advisable to seek legal advice when hiring gig workers. It is generally accepted that gig workers fall under the category of contract workers. However, the ruling by the Supreme Court in California could mean that there is a change in this area.
Being clear on the differences between employees vs. independent contractors can save your business from paying financial penalties. Misclassifying workers may result in your business being ordered to pay the worker’s employment taxes. If a contract worker claims that they should be an employee, you can appeal with a counterclaim and show evidence that your business relationship does not constitute that of an employer and employee.
You must try to stick to all the legal requirements when classifying a worker as an independent contractor. In order to satisfy as many of the contract worker requirements as possible, it is advisable to show that the work that is carried out is independent of your business.
Since there are tax implications when classifying workers and independent contractors, misclassification can mean that your company will be responsible for paying back taxes.
Should your company classify an employee as a contract worker, the worker has the right to bring an unemployment claim against your business after their contract has expired. This could result in your company being fined thousands of dollars by the Department of Labor.
Where a company classifies workers as independent contractors intentionally or fraudulently, they can face a fine of up to hundreds of thousands of dollars. The case of Norwood Commercial Contractors Inc. demonstrates the penalties that can be given for misclassifying workers. The company was ordered to pay nearly $400,000 for misclassifying some workers and failing to pay other employees for the hours they worked.
Different industries have distinct rules and regulations in terms of employee classification. For example, the healthcare industry is heavily regulated, so extra care needs to be taken when determining whether someone is a contract worker.
The guidelines above should help you when deciding whether a worker is an employee vs. an independent contractor. Although there is some ambiguity around the classification of workers, this type of uncertainty should not be part of other elements of your hiring process.
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If you need to hire employees, contract workers or a combination of both, sign up for a free trial of Fountain today to find out how we have helped companies like Safeway, UberEats and Deliveroo to simplify and boost the efficiency of their hiring process.
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