An employee is someone who works for you; an independent contractor is seen as having their own business and that business is doing a service for yours. As a result, your company must pay worker’s compensation and disability premiums, as well as state and federal unemployment tax and social security tax for each employee. A company doesn’t have to make these payments for an independent contractor. Since an independent contractor is seen as working for their own business, your company wouldn’t have to offer benefits and may be exempt from some regulations. Though it initially sounds like hiring all workers as independent contractors could save you money on taxes and benefits, the penalties can be quite expensive. It is important to classify your employees properly to avoid the risk.
So how do you know if your people should be classified as an employee or independent contractor? The Internal Revenue Service (IRS) and Department of Labor (DOL) have complex federal tests to determine if a worker is a truly an employee. However, there are some simplified ways to tell how the people working for you should be classified. An employee will perform tasks on equipment provided by the company, in a way directed by the company, during work hours set by the company. An independent contractor will perform a task that they were hired for using their own equipment, with only the end task dictated by the company (without oversight and direction from the company,) at a time they have decided to perform the task. In an example from Aabaco, a restaurant hires a server to wait on their customers. That server has a set schedule decided by the restaurant and his work is overseen and guided by a manager to make sure that it complies with the restaurant’s brand. The server is an employee. If the restaurant needs a new sign installed, they will hire a handyman who will use his own tools to install the sign, without being directed on how to do the job. After the work is done, the handyman might even ask to put up a sign advertising that the work was done by his own company. The handyman is an independent contractor.
If you do classify workers as independent contractors, make sure to protect your company. Don’t set their schedule for them, make sure that they use their own equipment, and ensure that they offer these services to other companies as well (collect any business cards or advertisements for their services.) If your company were to be audited and it was found that your independent contractors were working regular hours and their entire income came from your company, they would be deemed as employees and your company would be fined.
Don’t risk the costly fine. If your workers fit the definition of employee, it is crucial to classify them as such from the beginning.