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Ashley Cox with SproutHR is back for Reset 2019, and with a very timely and helpful post today! It’s tax season, and that usually means all kinds of questions for those of us who are self-employed creatives. Ashley explains the difference between independent contractors and employees.
Through SproutHR, Ashley helps small business owners step out of the day-to-day grind and into their CEO role with confidence. With over 12 years of leadership and human resources experience in both corporate America and the small business world, there’s not much she hasn’t seen, experienced or guided leaders through when it comes to developing their skills and leading their teams. Ashley believes that anyone can lead with impact – if they’re willing to look internally and do the necessary work. Be sure to check out her class on The Art of Delegation: How to Trust and Let Go.
Types of Workers
You’ve probably heard a lot of folks throw around terms like Independent Contractors and Employees.
But what do they mean and does it really matter which one you hire?
There are actually many different classifications of workers, according to the IRS, but to keep things simple, we’re only going to focus on these two for today.
Playing by the Rules
Different worker classifications have different rules that all businesses must follow (yes, even small businesses). Not following the rules can lead to big problems, so it’s important that you know the differences.
When determining whether a worker should be an Independent Contractor or an Employee, you must consider all the facts of the position. This will help you determine the Degree of Control your company will have over an individual that you’re planning to hire.
The IRS has outlined some common law rules to help guide businesses in classifying their workers properly. They are:
Behavioral
- Will the company control how the work is being done?
- Will the company control when the work is being done?
Financial
- Will the company control how the worker will be paid?
- Will the company reimburse expenses to the worker?
- Will the company provide training or tools for the worker to do his/her job?
Type of Relationship
- Is the work being performed essential or core to the business?
- Will the relationship be ongoing or long-term?
- Will the worker receive any benefits (vacation pay, insurance, etc.)?
Answering yes to any of the above questions doesn’t automatically mean that your worker needs to be classified as an Employee, but it does mean that you need to pause and take a much closer look.
Unfortunately, determining worker status isn’t as easy as answering a few questions.
There’s no magic formula or system that you can plug your answers into that shoots out a clear-cut answer for you. There are even cases where a worker might be classified as an Independent Contractor for one company or position, but might need to be classified as an Employee for another.
I know, it can get pretty confusing.
Your best bet is to get a pro to help you determine which type of worker you should hire for your company, so you can avoid ending up in hot water with the government. This is something I help my clients with all the time and I’d be happy to help you, too!
Can I get in trouble for treating an Independent Contractor as an Employee?
The short answer: Yes. Big time!
The longer answer: Treating an Independent Contractor as an Employee is what the government refers to as “misclassification of workers.” It’s a fancy phrase that simply means you mixed things up.
Now, you might have made an honest mistake. But the government isn’t big on excuses. As a small business owner, you’re responsible for knowing and following the rules of hiring and properly classifying your workers.
That’s just how it works.
Why is misclassifying workers such a big deal?
Over the years, a lot of businesses (both large and small) have hired Independent Contractors (instead of Employees) in order to avoid paying taxes, insurance, and other obligations that come along with hiring employees.
When you treat your Independent Contractor like an Employee (i.e. controlling when they work, how they perform the work, providing them with tools and training, etc.), then the government views that as an Employee/Employer relationship.
Why is this bad? Because when you misclassify an Employee as an Independent Contractor, they may be denied access to critical benefits and protections under federal law, which includes wage and hours laws, benefits, and civil rights and discrimination protections.
Why do employers misclassify workers?
Employers misclassify workers to avoid certain costs associated with hiring employees, including:
- Minimum wage and overtime laws
- Employer’s share of Social Security and Medicare taxes
- Employee benefits, such as vacation, sick pay, and holidays
- Unemployment Insurance
- Workers’ Compensation Insurance
These can definitely add up! But, if you are in the business of doing business, these are the rules of the game that you must follow in order to comply with Federal, State, and Local laws.
What are the consequences of misclassifying workers?
Let’s start with a question I know might be on people’s minds:
“Yeah, but…how would I get caught?”
Here are a few ways you might get caught.
- A worker who believes they’ve been misclassified files a complaint with the Department of Labor (DOL).
- A worker who has been classified as an Independent Contractor files for Unemployment Benefits or gets hurt while working for you and files a Workers’ Compensation claim.
- Random audits performed by the DOL or IRS, which covers all Independent Contractors and Employees you’ve hired for roughly a three-year period.
Note: the DOL and IRS have teamed up to do more audits over the past few years to crack down on small businesses misclassifying their workers.
By misclassifying your workers, you could be subject to a variety of penalties and fines.
If the audit finds that the misclassification was unintentional, you’ll still be subject to pay back pay, back taxes, and penalties for failing to file W2s and failing to pay taxes.
If the misclassification is found to be intentional, you could face even more severe penalties and fines, including criminal penalties and jail time.
A Final Word
Whether someone is an Independent Contractor or an Employee is determined by the nature of the working relationship.
Just because you issue someone a 1099 does not mean that they’re an Independent Contractor.
When a worker is classified as an Independent Contractor for one project or company doesn’t mean they’re automatically classified as an Independent Contractor for every project or company.