As a business owner or manager, especially in a small business with limited resources, there are definite advantages to hiring an independent contractor vs. an employee. Hiring a contractor may make sense when:
You need someone with very specialized expertise
You don’t have the space or equipment for an employee
You only need help temporarily, or for a small number of hours each month
You want help on a specific project, and no one in-house has the time or background to get it done
You need someone who will perform at a high level without much supervision or guidance from you
Many companies choose to hire independent contractors because, in general, employment laws, labor laws and related tax laws do not apply to independent contractors. However, there are specific criteria that an individual must meet in order to be classified as a contractor rather than an employee, and employers that misclassify employees as independent contractors expose themselves to expensive fines and litigation if an individual can prove he or she was an employee and did not receive a benefit or protection he or she was entitled to receive by law.
Classifying an Individual
Classifying an individual as either an employee or an independent contractor is not a simple task. No standard test has emerged to determine the true character of an independent contractor relationship. According to the IRS, facts that provide evidence of the degree of control and independence fall into three categories:
Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
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?
For more information, instructions and commentaries on this test, employers can rely on the IRS publication located on its website.
Other tests that can be used to determine an individual’s employment status include the Common Law Agency Test, the Economic Realities Test, and The Hybrid Test.
The Common Law Agency Test requires an intense consideration of 13 different factors that individually may not determine the character of the relationship between the employer and the worker, but as a whole allow for an understanding of how much control an employer exerts over a particular individual.
The economic test also requires a thorough analysis of the relationship between the parties and evaluates the level of financial dependency that the worker has on an employer.
As the name suggests, the hybrid test combines elements from the common law agency and the economic realities tests.
The Department of Labor also provides a list of factors that it says are “generally considered when determining whether an employment relationship exists under the Fair Labor Standards Act.”
If you’re planning to hire an independent contractor, be sure to do your research first. An employee could be a better fit for your needs, especially if you want a long-term solution and/or a high level of control over the individual’s work.
It’s also not a bad idea to evaluate all of your working relationships on a regular basis. These relationships are dynamic, and the changes that occur over time may impact the nature of the relationship between a worker and an employer. Employers that do not review the nature of their relationships with independent contractors run the risk of expensive fines and litigation procedures.