Important Details that Differentiate Employees and Independent Contractors

It might be tempting to classify employees as independent contractors to cut back on employment taxes, benefits, and other overhead costs that employers need to bear. But, employers need to understand the difference between these two classifications to ensure that guidelines are met for the workforce.

Why Does Employee and Contractor Classification Matter?

Even though the classification of your employees and contractors might seem like a small detail, the decision you make can have a big impact on your company. If your business is audited by the IRS and your workforce is misclassified, then you could be facing serious fines and consequences.

A few years ago, the United States Department of Labor released guidelines about employee classification and made it clear that it would aggressively pursue companies that misclassify the workforce by labeling employees as contractors. The Employment Development Department has also been consistent in enforcing the differentiation of employees and contractors.

Categories to Use for Classification

These problems can be avoided by carefully assessing the relationship with your workforce to make sure that people are being paid in the right way. According to the IRS, three main categories need to be evaluated to determine if the worker is a contractor or employee:

  • Behavioral: Consider the management style of an employee. Is the person given instructions on where to work, what time they need to be there, and how the work should be completed? Then the person is an employee, not a contractor. On the other hand, contractors have the freedom to manage their own hours, location, workflow and training without supervision from your company. Control over schedule and daily activities is a big piece in determining the classification for a worker or contractor.
  • Financial: When the company invests in the equipment or tools that the person is using, then it typically falls under the category of employment. Independent contractors are usually responsible for purchasing their own equipment and supplies. Operating costs are another factor that makes an independent contractor different from an employee, since the contractor needs to bear the burden. A contractor runs the risk of incurring losses due to bad debt, equipment problems, and overhead expenses. Another financial differentiation lies in the way the person is paid. Employees are guaranteed a wage for hourly or weekly work. Independent contractors are often paid a flat fee for the services that are provided.
  • Relationship: If the worker receives benefits, then it falls under the category of an employee-employer relationship. Usually, independent contractors don’t receive benefits. Also, an indefinite working relationship typically indicates that the person is an employee and not an independent contractor.

The IRS takes worker classification seriously, so you need to make sure that you are following the rules in the way employees and contractors are paid. If you need help determining the difference, then the best thing you can do is talk to a Human Resources expert. Call Cahue Enterprises for help with your workforce management and classifications: (951) 760-2870

*Disclaimer: Any information provided is for informational purposes only, and should not be construed as legal advice regarding any subject matter. Cahue Enterprises HR Consulting, Inc. is not assuming the position of legal advisor but instead aims to educate on human resources matters and compliance.