Employees vs. Independent Contractors

In the United States, how companies classify persons that perform services for them carries tax, unemployment, workers compensation, liability and other implications. The two primary classifications are employees and independent contractors. Whether a person is an employee or independent contractor depends on several factors.

The Legal Distinction

Essentially, the key element in determining whether a worker is an employee or an independent contractor is the amount of control the worker has over his or her job duties and what that person accomplishes or produces. A person who performs services for a business is usually an employee if the business or organization can control what will be done and how it will be done. In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.

Specifically, a court will look at factors that demonstrate the amount of control exercised by the employer over the individual providing services such as whether the employer or worker supplies the tools necessary for the work; who determines the worker's scheduling; any instructions and training provided by an employer; whether an individual performs regular or sporadic services to a business entity; and whether the worker has his or her own separate office or business.

Although an organization and an individual may sign an agreement characterizing a worker as either an employee or independent contractor, courts look past the contract and independently determine the appropriate legal classification based upon the actual working relationship. The court may consider the agreement to demonstrate what the parties intended, and who was benefiting by the arrangement. The Internal Revenue Service (IRS) has its own, similar test to determine whether an individual performing services for a business is an employee or independent contractor.

Who is an Independent Contractor?

The general rule for independent contractors is that these workers have the right to control or direct only the result of the work they perform, and not the means and methods of accomplishing the result. If a person performing services for a business supplies his own tools, works on his own schedule, receives little or no training, and works from his or her own office, generally he will be classified as an independent contractor.

For example, magazines or newspapers often hire freelance writers and photographers to create content for their publications. Because freelancers typically have their own offices, no set schedule, and simply submit content for publication without supervision by the media outlet over the way the work is performed, they are independent contractors and not employees of the media organization. Independent contractors may also be referred to simply as contractors, consultants, or free agents.

Who is an Employee?

Usually, someone who performs services for a business is an employee if the business or organization can control what will be done and how it will be done. If a worker goes to an office of a business regularly, has no control over scheduling, receives training and instruction from the business or organization, and does not have control over the work he or she performs, that person is an employee and not an independent contractor.

What Does the Distinction Mean?

Generally, an employer has to withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee, but not to independent contractors. Generally, an employer benefits more by classifying workers as independent contractors, because the employer will not have to pay employment taxes, health and insurance benefits, vacation and holidays, retirement plan contributions, and other costs that it would if those workers were employees.

Also, unemployment insurance benefits and state workers compensation systems are designed to protect employees, and do not protect independent contractors. If the business terminates that person's services, he or she generally will not be eligible for unemployment benefits. Similarly, most employment rights laws have been enacted to protect employees and not contractors. Independent contractors generally do not receive employment benefits and must provide their own health insurance, fund their own retirement plan, and pay other costs a business pays for its employees.

Tax Implications

Employers withhold federal and state income taxes, as well as social security, medicare, and other deducations, from their employees' paychecks. They turn these amount over to the government, along with their own share of any payroll taxes.

In contrast, companies pay independent contractors without taking out any deductions. Contractors themselves must calculate their income and self-employment taxes, and pay the government that amount on a quarterly basis. However, to the extent that independent contractors incurs any business-related expenses, they may be able to deduct those.

If a business incorrectly classifies an employee as an independent contractor, it may later have to pay employment taxes owed for that worker, plus a penalty. Anyone can get a ruling on employment status from the IRS by completing Form SS-8. The IRS does not recognize the validity of any written agreement between the parties, but considers factors evidencing control over services as courts do. Specifically, the IRS applies a 20-part test that considers evidence falling into three categories - behavioral control, financial control, and the type of relationship itself - to classify a worker as an employee or independent contractor.

Liability for Acts of Service Providers

Usually, a business that pays an independent contractor to provide services for it and does not control how the services are performed does not have legal liability for any injuries or damages caused by that service provider. An independent contractor is legally liable for his or her actions while on the job. For example, if a surgeon is not an employee of a hospital and only uses its facilities to perform his or her work as an independent contractor, the hospital will not be liable for any injuries or deaths caused solely by the surgeon's wrongdoing.