Employees vs independent contractors: What business owners need to know

Hiring for employees vs independent contractors

As a business owner, the decision whether to hire independent contractors or use traditional employees on payroll can seem straightforward at first.

Among the considerations: do I have a short-term need or a recurring one? Can this project be handled in-house or by a consultant? Pay more for outside expertise or cultivate talent from within?

Beyond operations, that classification will also have significant fiscal and legal ramifications, from payroll and tax withholding to recruitment and retention.

With end-of-year bookkeeping a priority as 2023 soon draws to a close, here are some key considerations for business owners faced with such choices.

Read More: 2023 Year in Review: Five new laws to watch for business owners

Employees vs Independent Contractors: Who’s in Control?

As far as the Internal Revenue Service (IRS) is concerned, it’s about control. The federal agency outlines a three-factor test to determine when workers should be deemed independent contractors as opposed to employees:

  • Behavioral control: Does the company control (or have the right to control) what the worker does, and how they do their job?
  • Financial control: Are the business aspects of the worker’s job controlled by the company (e.g., how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)?
  • Type of relationship: Are there written contracts or employee-type benefits such as pension plans, medical insurance and paid vacation/sick leave? Will the relationship continue and is the work performed a key aspect of the business?

More broadly, independent contractors (unlike in-house workers) generally won’t receive training, have greater scheduling flexibility (and can usually work from home or other locations) and greater latitude with how tasks get completed.

Unlike employees, contractors don’t have a continuing relationship with an employee but instead a finite one.

They are generally not restricted to working for just one boss. They typically won’t receive reimbursement for travel and expenses. Contractors are also responsible for paying local, state and federal taxes, as well as Social Security and Medicaid deductions, directly rather than through paycheck withholding.

In Florida, state law generally adheres to the same criteria as the IRS when it comes to determining the level of control an employer has over a worker. Those determinations, of course, have consequences: not just on the employee’s bottom line but as a matter of compliance – i.e., following guidelines, rules and the letter of the law.

Read More: Flexible work environments are easier with a PEO

Misclassification of Independent Contractors as Employees

Here’s what the IRS has to say:

“If you classify an employee as an independent contractor and you have no reasonable basis for doing so, then you may be held liable for employment taxes for that worker.”

Among business owners, a lack of understanding about contractor classification persists.

Courtesy of the U.S. Department of Labor, here are just some of the myths that persist about when workers can hang their own shingle versus when they must be on the payroll.

MYTH #1: If I am an independent contractor under one law, I am an independent contractor under other laws.
FACT #1: Even if you are a legitimate independent contractor under one law, you may still be an employee under other laws.

MYTH #2: If I am classified as an independent contractor, I am not eligible for unemployment insurance.
FACT #2: You may still qualify for unemployment insurance even if you are classified as an independent contractor.

MYTH #3: I received a 1099 tax form from my employer, and this makes me an independent contractor.
FACT #3: Receiving a 1099 does not make you an independent contractor.

MYTH #4: It does not make a difference if I am classified as an independent contractor or an employee.
FACT #4:  If you are misclassified as an independent contractor, you may be denied benefits and protections to which employees are legally entitled. Misclassification also has negative effects on businesses.

Misclassifying an employee as an independent contractor can also trigger penalties for non-compliance under state-specific workers’ compensation laws, which typically don’t allow for such designations.

Under workers’ comp, an individual is classified as either a business owner or an employee of a business. So if you hire an independent contractor to perform work for your company and do not ensure they have their own workers’ compensation, your insurance carrier will consider that individual an employee of your company — and assume that all wages paid to that employee are subject for premium.

The main contractor has full responsibility for ensuring that the independent contractor has provided coverage for themselves and their workers. If a worker is injured without being protected by insurance, then the main contractor becomes responsible for the payment of benefits. This could put your workers’ insurance at risk of cancellation.

Employee vs Independent Contractors: How to Decide

Still not sure whether to classify a worker as an employee versus an independent contractor? IRS Form SS-8 (Determination of Worker Status for Purposes of Federal Employee Taxes and Income Tax Withholding) allows both businesses and workers to receive a formal determination of worker status from the federal agency.

That said, such determinations can take at least six months, so a word of advice: don’t wait until Dec. 31 (or even worse, April 15 of next year) to make sure your workers are properly classified. You owe it to your bottom line – and to your workers, whether contractors, part-timers or full-time.

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