If you are the owner of a business who does not know the difference between an employee and an independent contractor, you could be in trouble with the state and federal government. As a worker, how you are classified could have an effect on how the amount you are paid and the benefits to which you are entitled.
Independent contractor law imposes rules on business owners and workers that would not apply to employees. For example, independent contractors and employees are responsible for reporting their income and paying state, local and federal income taxes at the end of the year. However, employees have income taxes withheld from each paycheck and receive a W-2 at the end of the year while an independent contractor receives a 1099 and do not have taxes withheld.
The IRS offers guidelines for workers and employers to use in order to classify someone as an independent contractor or an employee. There are seven major general factors that distinguish an employee from an independent contractor.
Behavioral: It’s all about control
What sets an employee apart from an independent contractor is the amount of control the company or person for whom the work is being performed has over the worker. Employers have control over the following aspects of a worker’s day:
- Hours worked
- Setting daily goals as far as sales or completed work
- Directs the manner in which the work is to be performed
- Assignment of helpers or other workers to assist with the job
On the other hand, independent contractor law gives the person providing the services much more freedom than is given to an employee. The company for which an independent contractor is hired to do work is looked upon as a customer instead of as an employer. The relationship is created by contract law because it is based upon an agreement, whether written or verbal, that sets the scope of the work, the compensation and the intended outcome.
Financial: Waiting for a paycheck or for a payment
One of the factors setting employees apart from independent contractors has to do with money. Employees receive a paycheck with income taxes withheld while an independent contractor receives the payment agreed upon for the work without anything taken out for taxes. Independent contractors are responsible for providing and paying for the supplies, tools and materials needed to complete the job. An employer provides whatever an employee needs to do the work.
Relationships: How did it all begin, and how does it end?
Employees are hired and continue at their jobs until they voluntarily quit or are terminated by the employer. The relationship between an independent contractor and a customer begins with an agreement to do the work, and it ends when the work is completed. Although most states have at-will employment laws that allow employers to terminate a worker’s employment without cause, employment relationships tend to last much longer than relationships under independent contractor laws that end with the completion of a particular job or project.
Legal Protection: Federal and state labor laws
Federal and state labor laws provide protections for employees that might not be available to independent contractors. Some of the key federal labor laws include:
- Fair Labor Standards Act: Private- and public-sector employers must pay wages and overtime pay according to standards and guidelines established by the U.S. Department of Labor. This includes compliance with minimum wage and overtime pay rules that would not apply to independent contracts that are paid according to the agreements they reach with their customers. Although independent contractors would not fall within the enforcement provisions of the Fair Labor Standards Act, it would apply to them as employers in the event they have employees working for them.
- Occupational Safety and Health Act: OSHA regulations apply to employers in the public and private sectors. The law imposes a duty on employers to provide a safe workplace and authorizes inspections to verify compliance with the law.
- Family and Medical Leave Act: Employers with 50 or more workers must allow their employees to take up to 12 weeks of leave for the birth or adoption of a child or for a serious illness of the worker or a spouse or family member. The leave is without pay, but the law provides job protection for the worker.
Benefits: Independent contractors are usually on their own
A contractor would not be entitled to receive the same benefits, such as health insurance, disability payments and unemployment compensation, which are available to employees. One area in which the distinction between employment law and independent contractor law is the most pronounced is workers’ compensation requirements.
Workers’ compensation laws protect employees injured through job-related accidents or illnesses by requiring employers to provide insurance coverage that pays an injured worker’s medical expenses and lost earnings. The purpose of workers’ compensation laws is to allow injured workers to receive the medical care they need to return to work without having to resort to filing a lawsuit against the employer. In fact, workers’ compensation laws generally prohibit injured workers covered under them from suing their employers.
Most states do not extend workers’ compensation benefits to individuals working under independent contractor laws. An independent contractor would be expected to provide insurance coverage to pay claims if he or she is injured while working.
Unions: The right to organize
Labor unions offer workers the strength that comes from being able to negotiate with employers as a group rather than as individuals. Many work-related issues, such as wages, benefits, work schedules, overtime pay and workplace safety, can be achieved through collective bargaining carried out by a union acting on behalf of all of its members instead of on a worker by worker basis. The old adage of there being strength in numbers is the foundation upon which labor unions function and exist.
Independent contractors do not have the benefit of a labor union or collective bargaining backing them when negotiating the agreements under which they work. Contractors might belong to trade associations or organizations made up independent contractors, but such groups do not act as the representative of their members to negotiate contracts and agreements with customers.
Investment: Independent contractors invest in themselves
As a general rule, independent contractors have no stake or investment in the project or job they agree to perform. A tractor-trailer operator who submits a bid to haul a manufacturer’s goods across the country and deliver them to a wholesaler has no stake or investment in the cargo. The operator is paid the agreed upon compensation based upon the submitted bid. The operator’s investment is in the truck and other equipment he or she owns and uses to carry out the terms of the contract with the manufacturer.
Employees, in contrast, work for an hourly wage or a fixed salary and do not have any investment in the equipment, machinery or materials they use to perform their jobs. Everything they need for the task they are assigned is provided to them by the employer.
Diversity: The freedom to work for many
One of the attractions of working under independent contractor law rather than as an employee is the freedom to work for more than one customer at a time. Employers frequently impose restrictions on outside employment by their workers where such extracurricular activities might conflict with the work for which the individual was hired.
For example, someone hired as a sales associate by a retail store might not be permitted to get a second job working for the store’s competitor if the first employer believes such an arrangement could be harmful to his or her business. The employee would have to make a choice of foregoing the second job or leaving the current employer.
Absent an agreement to the contrary, independent contractor laws allow a contractor to work for anyone he or she chooses. It is common for an independent contractor to work for more than one customer or client at the same time. The limitation on this ability to work for multiple people or businesses is one that the independent contractor has an option to accept or decline.
A business might attempt to impose a limitation on work performed by others by an independent contractor, but this would have to be presented during the negotiations leading to the agreement between the contractor and the business. The independent contractor has the option of declining to accept the restriction on other work, but the business has the right to decline to retain the services of the contractor under such circumstances.
Categorizing someone as an independent contractor who is actually an employee can create tax and legal issues for both the employer and the employee. An employer might attempt to avoid withholding taxes or benefits payable to employees by classifying a worker as an independent contractor, but the Internal Revenue Service and other government regulatory agencies can impose penalties if the misclassification is discovered. A consultation with an attorney could help to answer questions you might have about independent contractor law and how it applies in your situation.