As you expand your business, one of the common decisions you need to make is whether your next hire should be an employee or an independent contractor.
There are plenty of internal factors you should consider when determining which route to take. For this article, we will be focusing on what determines an employee vs an independent contractor.
The IRS helps employers determine employees versus independent contractors based on three areas, behavior control, financial control, and the relationship of parties. Before we dive into these categories, let’s first talk about why this matters.
Why Does This Distinction Matter?
It can be more expensive for a company to hire an employee over an independent contractor due to income taxes, social security, medicare taxes, and unemployment taxes. So sometimes it can be tempting to smear the lines a bit and classify someone as an independent contractor, when they should be an employee.
Some states have even been cracking down hard on business owners, like California, imposing fees on those who do not comply.
Behavioral: The employer has the right to instruct how the employee should conduct business and make adjustments to performance.
- Employer influences when and where the employee can work. Such as office location, meeting times, and hours of operation.
- There is a higher level of instruction, which may involve training, mentoring, or more detailed requirements of the work.
- Employers regularly encourage and provide training to employees on how to improve their skills or work within the organization more efficiently.
Financial Control: The business has a right to instruct the business expenses and income of the employees job.
- Employees are more likely to be reimbursed for their expenses.
- The employee does not carry the risk of losing personal assets based on their work.
- Generally, employees are not free or able to easily seek outside work from other employers.
Relationship: These aspects of the relationship define the acceptable interactions between the employee and employer.
- Often, employees are subject to some benefits like vacation pay, sick pay, or health insurance.
- The term of the agreement with an employee is usually considered indefinite until one party terminates the agreement.
- Employees are often seen as integral parts in keeping the business running.
Behavioral: The employer has limited authority on controlling how the independent contractor conducts their business.
- Employer does not influence when or where the independent contractor does their work. For example, the contractor can stipulate they only work within a certain range of hours and conduct their work at home or office of their choosing.
- The employer offers limited instruction and the independent contractor has more influence over how the job can be done.
- Independent contractors participate in training on their terms and by their methods.
Financial Control: The business does not have the right to instruct the business expenses and income of the employees job.
- It is uncommon for independent contractors to be reimbursed for their expenses.
- Independent contractors carry the risk of profit or loss when performing work for the employer.
- Independent contractors have the freedom, and generally the capabilities, to seek out work from other employers.
Relationship: These aspects of the relationship define the acceptable interactions between the contractor and the employer.
- Generally, benefits like vacation, sick pay, or pension plans are not offered to independent contractors.
- Independent contractors likely have an agreement made up that determine how long a contractor will be employed, either determined by time or project based.
- Independent contractors rarely perform key services that are part of keeping the business running.
Expanding your business is an exciting time, but it is important you properly classify each new worker that helps your organization grow. So when your payroll grows or you need to file additional 1099’s be sure to contact your accountant to make sure you are in compliance.