Independent Contractor vs. Employee which is right for my business?

So your business is growing and it’s time to get some help.  You reach out to your network and find a willing soul who will help you with the everyday tasks that need to be accomplished in your business, agree to a compensation rate, and just like that you have your first employee!

Or do you?  Or maybe a more provocative question is do you want to have an employee?

When’s the time to expand?

Expanding your business is a touchy subject.

Do you wait until you have 40 hours of extra work to do so that you can hire a new full time employee?  Or is it better to find a part time person to fill the gap that exists now?

Technology has helped business owners and managers better understand the needs of their business in terms of when workers are needed, and because of this increased insight on-demand workers or the “gig economy” has boomed in recent years.

This boom has brought the topic of whether or not workers are employees to the forefront recently as Uber and Lyft have been involved in major lawsuits trying to understand the nature of the relationship.

If Uber and Lyft are willing to spends large sums of energy, time and money to fight their driver’s classification as employees then this must be a big deal, but what is at stake?

The 7 major factors that make this an important decision.

Liability 

If an individual were to be injured while performing a task for your company who would cover the expense of their treatment?  An employer should carry a worker’s compensation insurance policy to limit their risk.  An independent contractor should have their own policy.  The risk involved here varies greatly based on the work being performed, but this is required by state law in most states.

Income Taxes

The internal revenue service relies on payroll taxes to fund the daily activities of the government.  This is mainly funded through withholding from employee’s paychecks.  If a worker is considered a sub-contractor, then they are responsible for calculating and paying their income taxes and they are only required to pay their income tax once per quarter.  So the IRS would prefer employees because the cash flow is better for them.

Social Security

Social Security benefits are calculated based upon an employee’s gross wages.  Social Security benefits are based on a sub-contractor’s net income.  That is the amount of income left over after subtracting the expenses incurred to realize the activity.  So a worker who is thinking about retirement would probably prefer to be an employee.

Unemployment

An employee has the right in most states to receive unemployment benefits if they lose their job, however a sub-contractor does not have that right.  So a worker would be more interested in being considered an employee so that they have greater income protection in the event that the job is terminated.

Department of Labor

The Department of Labor has the responsibility to be sure that employers are paying their employees (regardless of if the employer calls them employees or calls them sub-contractors) minimum wage, and overtime when it is appropriate.  Failure to meet the standards set by the Fair labor Standards Act involves punitive fines against the employer so compliance with this in everyone’s interest.

Cost

Naturally the business owner wants to keep the cost as low as possible, and all of the points discussed thus far require additional cost.

Worker Retention

With unemployment hovering around 4% workers have a lot of options, and sticky fringe benefits such as health insurance, and dependent care reimbursement programs can make it easier for an employer to keep talented workers.  However, those benefits can only be extended to employees.

Why is it so hard to tell if a worker is an employee or a sub-contractor? 

Well the problem is that there are no crystal clear expectations.  The Department of Labor has 7 points that it considers when determining the independence of a worker.  The IRS identifies three main areas with multiple points to consider within each one.  State Unemployment Taxing agencies have their own criteria as well.  The Department of Labor and the IRS say that there is no one defining characteristic that determines the nature of the relationship.  It is a combination of all as interpreted by the auditor or judge.

I have paraphrased the seven Department of Labor points as questions to help you better understand the nature of the evaluation point.

What work will they perform?

Does the worker perform the core service that your business provides?  If you have a T-shirt screen printing shop, it is not the same to hire the guy who runs the machine that prints on the T-shirts as a part time marketing person to help with your advertising.  The more core they are to your business the less likely that they are an independent contractor.

Is this temporary or permanent?

How long will the worker been working with your business?  Do you call this person only to solve a succinct problem such as you might call a computer technician to come fix your computer if it goes down, or are they expected to show up everyday at 9 am until further notice?  The more permanent the relationship the more likely it is you have an employee.

Does the worker have skin in the game?

Does the worker have to make any sort of investment in tools, facilities or equipment to perform the job?  Generally if a worker has to purchase their own tools then that is a sign that they are an independent contractor, however in the trades there is much more variety.

Who is in control?

How much control do you exert over the individual, and by what means is it implemented?  If you hire a person to mow the lawn in front at your place of business, do you tell the person to first trim, then mow and then pick up, or do you tell that person “Thanks for coming.  Here’s the lawn I need cut, let me know when you’re done and I’ll write you a check”?  The name independent contractor comes from the concept that they work independently and do not need to be trained to do the work that they have been hired to do.

What is the upside for the worker?

Does the worker have any control of their own profit or loss in the activity?  Although there are definitely exceptions, employees normally have very little direct opportunity to increase the profitability of their actions on a day to day basis.

Does the worker have a business card?

Does the worker actively compete in the open market with others providing the same or similar service?  Do they have a website?  Do they understand the competition and what sets them apart?  Generally these are signs of an independent contractor.

Does the worker have a trademarked name?

Well maybe that is an overstretch as many businesses haven’t invested in trademarks, but the real question is does the worker have their own business set up?  If they do then they are probably not an employee.

Given the possible pitfalls, how can you proceed with confidence? 

The IRS has a FAQ which answers some questions.  The Department of Labor has also provided guidance.  Industry standards are another guideline as to what is acceptable, however it is not safe to assume that just because “everyone” is doing it a certain way that there is no risk involved.

Another good source is to chat with a qualified professional.  An accountant or lawyer can help ask the appropriate questions to help you understand the nuances of your particular situation.