Guidelines for determining whether you are hiring an independent contractor or employee
How to decide between hiring an independent contractor and an employee is one of the questions I get asked frequently. This is a very important distinction because categorizing someone as an independent contractor when they should be classified as an employee can lead to legal and financial headaches and penalties.
I know that hiring people as independent contractors is appealing because you don’t have to withhold income tax, withhold and pay Social Security and Medicare taxes or pay unemployment tax. However, if you are found to have mis-classified someone as a contractor when they were really an employee, that discovery by the state and federal government can eat up all those savings with interest and penalties, so be very careful when making this decision.
For the payer, the IRS has written a relatively simple statement in their checklist: “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done.”
Let’s break this down a bit to make it clearer.
Here are the key areas you should examine to make the determination.
Instruction about how, when, and where to do the work.
NOTE – this is an area to which the law pays particular attention and is often the most important determining factor in deciding which status to choose.
How much instruction you give to the person is the single most important aspect of the relationship to consider. An independent contractor, for the most part, will decide how they want to get the work done. An employee not only receives instructions, but also evaluations of their performance. So, giving someone consistent feedback on their work is usually a sign that this person should be considered as an employee. Employees are open to more regular evaluations while contractors tend to get feedback on an as-needed basis.
Contractors will come with pre-set skills that they are offering so in this arrangement; they are given a task and do with little to no instruction. In the employee relationship, they are given a lot more supervision and guidance along the way.
Employees are offered training, usually as a company expense, while contractors find and pay for their own training.
The Arrangement of The Ongoing Relationship
Contractors often have more than one client they are working with. They are free to seek employment elsewhere. Employees usually work for one company. Obviously, there will be instances when contractors work with a single business and employees can work for more than one company, but the contractor has no obligation to discuss or reveal the other jobs while employees, in order to maintain their schedules, may have to be more open.
An independent contractor will decide how and where to work while an employee has set hours. While you might ask a contractor to work particular hours, they have a right to say no while an employee more often has a set schedule.
Independent contractors should have a contract with you and should be sending you invoices. This does not necessarily mean that this qualifies them for contractor status but it’s a good way to both protect yourself and to make a distinction. A typical contract will have a start and end date and spell out a specific project or two as the focus of the work.
Using best practices, employees are hired with no end date and are given job descriptions and offer letters and go through an on-boarding process. Even part-time employees should go through these same processes.
Contractors don’t get benefits, while employees do. In fact, this has become a way for some companies to save money, whether it’s right or wrong. Making someone a contractor to avoid paying benefits may not be wise if the other factors are not in alignment with the overall criteria, particularly in the area of the level of instruction given.
Contractors do not supply key elements of your business. For example, if your business does house cleaning and you hire people to clean those houses, they are probably going to be considered employees, not contractors. If you’re a realtor and you hire someone to clean a house you are selling, that is a contractor.
The Financial Relationship
The independent contractor will buy their own equipment while the company will supply the equipment needed by the employee. The contractor will often bear more of the burden of incurred expenses unless spelled out otherwise by the contract. The employee will often be reimbursed for out of pocket expenses.
The independent contractor has their own financial statements with their individual profit and loss, balance sheets, etc. They have an ongoing business with a variety of clients.
Employees are paid a guaranteed wage, which may include commissions while contractors are paid for the job with a flat fee.
As the IRS says in this website directed to people who are trying to decide for themselves if they are an independent contractor or not,”You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done).”
Some business owners have decided to hire people as contractors in order to be able to let them go more easily if they don’t work out. Keep in mind that Pennsylvania is an “at will” state. From the PA. gov website: “In Pennsylvania (like a number of other states), workers will generally be considered to be “at will” employees unless they have an employment contract or statutory right that provides otherwise. An employer may terminate the services of an “at will” employee, with or without cause, at any time â€” as long as an employee is not let go for an unlawful purpose, such as age or racial discrimination. Conversely, “at will” employees have a similar right to resign their employment, for any reason (or no reason at all), at any time. So wile you will save the time and effort of documenting the person as an employee, if you are only worried about being able to fire someone who is not working out, if you are in one of the 14 states with the “at will” law, you may simply fire the person if you can prove it was not based on discrimination.
Keep these guidelines in mind when hiring. I know from speaking with many business owners that it is easier to hire contractors. There is a lot less set up, record keeping, tax liability, etc. However, I know businesses that experienced the IRS deciding that their staff was mis-classified as contractors when they should have been employees, and it cost them thousands of dollars.
If you have any doubts, feel free to call me and I’ll be happy to review the situation with you! [email protected] or 215-868-1283