Hiring Workers - The Difference Between Employees and Independent Contractors

As a business owner, you are often challenged to find talented staff to help your business meet its obligations and grow. Many entrepreneurs believe that simply hiring support staff via a “1099 independent contractor” is a viable option without understanding the sometimes-costly legal ramifications of such a decision. What do I mean by that?

It may come as a surprise to some that there are very strict rules — imposed by the Department of Labor (DoL), the IRS, and state agencies — on how workers are to be classified. Is someone truly an independent contractor or would the law determine them to be an employee? The rules don’t consider the desires of the business owner or the worker and the consequences of misclassifying can be very costly.

So, here’s what you need to know.

Is My Worker an Independent Contractor or Employee?

Unfortunately, there is no hard and fast rule to guide you in determining whether a worker is considered, under the law, an employee or an independent contractor. Whether it is the DoL, IRS, or a state agency, all use various factors to determine how a worker is to be classified. The DoL and IRS factors are similar and consider several criteria including:

• Is the service the worker provides an integral part of the principal's business — meaning how essential is the worker to your business? Are they key to what you are doing? The more essential they are to your business, the more likely they will be considered an employee
• How permanent is the relationship — meaning is this a short term, or long term engagement? The longer the engagement the more likely the worker will be considered an employee
• Does the worker bring his or her own equipment or tools and the like? Meaning, if you provide office space, a computer, phone, email, etc. the more likely the worker will be considered an employee
• Do you direct and control the work being performed? If so, again, the more likely the worker will be classified as an employee
• Is the worker financially independent — meaning he or she has his or her own business and several clients such that he or she is not financially dependent on his or her engagement with your company

Legal Implications of Misclassification

If you misclassify an employee as an independent contractor you can face daunting liability. For example, if an independent contractor is deemed an employee, you would be liable for employment taxes and employee benefits, plus potential penalties, back to the date of hire for that employee.

Let’s look at a couple examples.

Hotel Misclassified Staff as Independent Contractors — To the Tune of $119,434

In a 2015 case, the DoL found that a small Kentucky hotel misclassified their housekeeping, laundry, front desk, and maintenance staff as independent contractors rather than as employees, thereby denying them minimum wage and overtime compensation as required by law.  A consent judgment was entered, in which the employer was directed to pay $119,434 to 43 employees, which included back wages. The complaint also alleged that the employer violated anti-retaliation provisions by intimidating employees who were cooperating with investigators.  

Contractor Misclassified Workers as Independent Contractors — Resulting in $20,240 in Fines

In another case, an administrative judge ruled that a Connecticut contractor misclassified employees as independent contractors to avoid their responsibility to provide a safe workplace.   The contractor claimed that the workers were not employees because they worked under their own supervision, supplied their own tools and made their own hours. Upon review, the administrative law judge found that the DoL established that the company had control over the workers and work site safety, provided them with tools and equipment needed for the project, determined when and for how long the individuals worked, and paid hourly wages to the workers.  $20,240 in fines was assessed.

There’s a place and a time to hire an independent contractor, but be sure to consider how the law would view that worker and, if you have questions as to classification, seek guidance. In this situation, an ounce of prevention really is worth a pound of cure.

If you have questions about how your workers should be classified — or how to clearly define a role to meet the criteria for independent contractor status — I welcome you to contact me.