Independent Contractor vs. Employee – The Differences Explained

Market forces are bringing this issue into the Spotlight.

The rise of the Freelance Economy has brought about major shifts in the US work force as more and more companies prefer the hiring model of Independent Contractor vs. Employee. While there are many reasons for the shift – among them cost savings and companies’ desire for a more flexible workforce – companies must be very careful to ensure that they don’t call employees contractors in the hope of skirting around a few regulations. Using this as a device to save on items like social security, unemployment taxes or benefits can be a costly mistake.

It’s often not easy to determine, and there’s no magic bullet.

While contractors certainly have their place, the IRS and other government agencies have carefully spelled out the parameters under which companies can claim contractor status for a worker. The rules aren’t always clear – even the IRS admits There is no ‘magic’ or set number of factors that makes the worker an employee or an independent contractor, and no one factor stands alone in making this determination.” However, the rules are there to guide companies into making a sound decision.

The basic IRS rule on independent contractor vs. employee is that the worker must have “independence of action.” What this means is that you, as the employer, cannot control the time or circumstances of the work being done. For example, you cannot hire a “contract” financial Controller and then demand that she work from 9:00 am to 5:00 pm, nor can you dictate exactly how the work is performed. Contractors are free to work their own hours and to perform the work in their own way. For this test the employer has to limit his involvement to what gets done, and not how it gets done. This isn’t to say that the employer can’t impose conditions on the job, such as telling the contractor that X amount of work must be done by Y date, but the employer must be very careful to allow the contractor their independence as to the how and during what hours work gets completed.

The IRS rule defines “independence of action” in this way:

Does the company control or have the right to control what the worker does, and how the worker does his or her job?

This is known as behavioral control. In a nutshell, if an employee is to be considered an independent contractor the employer cannot tell the worker:

  • When and where to do the work.
  • What tools or equipment to use.
  • What workers to hire or to assist with the work.
  • Where to purchase supplies and services.
  • What work must be performed by a specified individual.
  • What order or sequence to follow when performing the work.

Employers should also beware that they don’t provide overly detailed instructions to the worker. In its rulings on the issue, the IRS has held that the more detailed the instructions given the worker, the more likely he or she is to be considered an employee and not a contractor.

In Part 2, I discuss more of the independent contractor test and how to pass it.

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