Independent Contractor Versus Employee and Why Your Business Must Know the Difference

Independent contractors, also known as 1099 workers, are self-employed individuals. Many businesses use independent contractors for isolated projects that are outside the scope of their normal business. And while the independent contracting system has been beneficial to our economy, it is also subject to frequent abuse.

If your business uses 1099 workers, it’s essential to understand the difference between them and bona fide employees. Failure to do so could expose your company to tax and legal penalties. The Oracle Legal Group provides practical guidance.

1099 Versus Employee

Independent contractors are also called 1099 workers because of the tax forms they are issued. These individuals work for themselves and have established trades or professions. They provide a service to various businesses on a contract basis.

As self-employed persons, they are not employees of the companies to which they provide their services. Independent contractor services are outside of the normal business in which the company is engaged. An example is a forensic accountant hired by a company to audit the business.

Employees, on the other hand, work directly and indefinitely for a single company on a continual basis. Employee work is directly in line and consistent with the company’s normal business objectives and purposes.

The company that employs these individuals also provides other benefits besides pay that 1099 workers don’t enjoy. These include health insurance benefits, participation in retirement plans, and tax withholding. Since employees have greater benefits than contractors, they cost the company more.

This leads many employers to misclassify their employees as 1099 workers. Put simply, it costs a company much less if it can classify someone as a contractor. But doing so incorrectly could land the business in hot water. The IRS, Department of Labor, and state agencies can levy significant financial penalties against companies that do so.

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How Can a Business Distinguish Between Employees and Independent Contractors?

The IRS has various criteria that employers can use to better understand whether a worker is a contractor or an employee. First, it should be noted that merely labeling a worker as an independent contractor is not sufficient. Even signing a contract with the worker does not necessarily accomplish this.

These are a few signs that you may have misclassified an employee as an independent contractor.

You Direct and Control the Work.

The employer’s degree of control and direction plays a major role in determining the worker’s status. For instance, does your company:

  • Decide when the worker shows up to do the work?
  • Set the number of hours the worker can work?
  • Control what work will be performed?
  • Dictate the manner in which this work will be done?
  • Determine the method of paying the worker?

If so, the worker is probably an employee.

You Provide the Tools and Equipment That Workers Use.

An independent contractor should have an established business sufficient to do his or her work for various companies. That means the contractor should already have his or her own tools or equipment to perform the work. Conversely, if a company provides the tools, supplies, and implements, an employer-employee relationship is more likely.

You Set the Earnings.

If a worker is regularly (e.g. weekly) paid a predetermined amount, the worker is probably an employee. Employees don’t lose money by doing their jobs. Independent contractors, on the other hand, can realize profits or losses in their work.

The Worker Provides Services That Align With What Your Company Does.

If the worker’s services differ substantially from what your company usually does, this person may be an independent contractor. An employee is someone whose regular tasks directly advance the business objectives of the employer.

The Worker Has Not Invested in His or Her Business.

Employees usually don’t invest money or other resources into the employers that hire them. Such risks are the employer’s responsibility. Meanwhile, an independent contractor has invested money in his or her own business and thereby assumed financial risk.

You Have a Traditional Employee Relationship With the Worker.

Is your relationship with the worker brief or indefinite? Do you provide the worker with standard benefits like health insurance and tax withholding? Evidence of a traditional employee-employer relationship can be substantial.

Know Your Rights and Duties

Our goal at the Oracle Legal Group is to help employers understand their rights and legal duties. Do you use independent contractors but want to make sure you aren’t running afoul of the law? Give us a call at 832-291-2798 or contact us online to learn more.