Independent Contractors Vs Employees: Knowing the Difference Makes All the Difference

October 10, 2016

Deciding whether a worker is an independent contractor or an employee can be tricky, but knowing the difference can greatly affect proper tax compliance—but it’s not as simple as you might think.

Many employers either find classification confusing or deliberately mislabel their workers. In 2013, the Internal Revenue Service (IRS) estimated that US employers classify millions of workers as independent contractors instead of employees. By incorrectly labelling workers, companies avoid having to pay some employment taxes, which can harm incorrectly labelled employees whose share of taxes is not withheld—and cannot be deducted from their gross income.

Why Do Companies Mislabel Employees?

There are many reasons companies label employees as independent contractors, but the biggest reason is simple: saving money. Those classified as employees are entitled to Fair Labour Standards Act protection, like minimum wage, overtime pay, unemployment insurance, and workers’ compensation. However, independent contractors are not covered by FLSA’s protection.

Labeling employees as independent contractors means companies don’t have to provide the employee with overtime pay, benefits like time off and sick pay, unemployment compensation tax, employer’s share of Social Security and Medicare taxes, and workers’ compensation insurance. Seems like labelling more employees as independent contractors can save your company a lot of money—but if you get caught, you’re liable to lose a lot more.

What Happens If Companies Are Caught Mislabelling Employees?

If an employee believes they have been misclassified as an independent contractor, they have the right to file a complaint with either their state’s Department of Labour or the US Department of Labour. Your company could then be subject to a DOL investigation, and the consequences can vary, depending on whether the misclassification is viewed as intentional or unintentional—or even fraudulent.

Uber recently made headlines for claiming that its drivers were independent contractors instead of employees. By labelling their drivers as independent contractors, Uber didn’t have to worry about paying for their drivers’ cars, gas, or any other incurred charges. An Uber driver took the company to court for this, and the judge ruled in the driver’s favour; the company ended up shelling out approximately $100 million to about 450,000 drivers in California and Massachusetts. However, the lawsuit didn’t change Uber’s business model; they still categorise their drivers as independent contractors.

Getting caught mislabelling employees simply isn’t worth the risk. So what can your company do to ensure your employees aren’t misclassified?

What Can Your Company Do?

In an age when employee misclassification is more prominent than ever, labour law compliance is vital to companies’ success. An obvious tactic to ensuring compliance is simply being extra diligent, knowing how to determine whether workers are employees or independent contractors. According to the IRS, employee classification depends on “the degree of control and independence” between employees and employers, which falls into three categories:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Another good rule of thumb is the six factors the Department of Labour considers imperative in determining employee status:

  1. Is the work an integral part of the employer’s business?
  2. Does the worker’s managerial skill affect his or her opportunity for profit or loss?
  3. How does the worker’s relative investment in facilities and equipment compare to the employer’s investment?
  4. Does the work performed require special skill and initiative?
  5. Is the relationship between the worker and the employer permanent or indefinite?
  6. What is the nature and degree of the employer’s control?

In addition to adhering to the IRS’ and DOL’s employee/independent contractor classification rules, you can ensure compliance with Asure Software’s People Success Platform. Asure can help you navigate the complicated and confusing aspects of FLSA and ACA compliance with a streamlined, single database system to secure tax and labour compliance and reduce headaches.

Sources:

https://www.treasury.gov/tigta/auditreports/2013reports/201330058fr.pdf
http://www.huffingtonpost.com/2015/06/17/uber-independent-contractors_n_7604366.html
https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
https://www.dol.gov/whd/regs/compliance/whdfs13.htm