How do I know whether a worker should be classified as an employee or an independent contractor?

How do I know whether a worker should be classified as an employee or an independent contractor?

The difference between an employee and independent contractor comes down to the amount of control and responsibility the employer has over them. While there are several advantages to hiring an independent contractor rather than an employee, misclassifying an employee can have severe legal ramifications. And yet several studies show that 10-20% of employers misclassify at least one worker as an independent contractor. It's important to understand the differences and how to reduce your risk of liability.

What are some differences between employees and independent contractors?

Why do employers hire independent contractors?

1. Cost savings: Employers don't have to pay for benefits, such as health insurance, retirement plans, and paid time off. Nor are they resonsible for payroll taxes or workers' compensation insurance.
2. Flexibility: Independent contractors can be hired on a project-by-project basis and are not obligated to work a set schedule or specific hours. This allows employers to have more flexibility in staffing to meet changing business needs.
3. Reduced liability: Employers are not typically liable for the actions of independent contractors.

While there are advantages to classifying a worker as an independent contractor, many employers aren't aware of the legal ramifications of misclassifying an employee.

What can happen if I misclassify an employee as a contractor?

In 2016, Lyft paid $27 million to settle a claim that their drivers, classified as independent contractors, are legally employees. The argument was that their drivers perform essential functions, and that Lyft exercises a significant amount of control over how their drivers work. While California Proposition 22 now allows Lyft drivers to be classified as contractors, the distinction is battle that Lyft continues to fight — and if they lose, could force them to pay millions in back wages and expense reimbursements.

The case showed how much gray area there can be when classifying a worker. You'd think that if a driver can choose their own hours, they'd be independent. But Lyft can assign particular rides to drivers, controlling when and where they work. Drivers use their own vehicles, but the vehicles must meet quality standards as determined by Lyft.

Understanding the minute differences between independent contractors and at-will employees cannot be undervalued. If you are uncertain of the correct legal classification of each of your workers, conduct an audit now before any potential claims occur.

 How do I reduce the risk of a misclassification claim?

Besides ensuring that you are correctly classifying a worker, you also should be careful about the language you use in agreements you give independent contractors. Verbiage that implies an employment relationship is evidence that can be used to back up an employee claim.

Clearly state that the contractor is an independent contractor and not an employee.

Outline the specific services that the contractor will be providing and the expected outcome, without providing details about how the work is to be performed.

Avoid language that suggests you have control over the contractor's work, including work hours, work location, and the tools or equipment used to perform the work.

Specify the payment terms, including the rate of pay and the method and timing of payment.

 What tax form do I need to give independent contractors?

 While there are several types of 1099s, depending on the types of payments made, the most common is 1099-NEC, used to report non-employee compensation. A less common 1099 Form is 1099-MISC, which is used if you award an independent contractor a monetary prize not part of their regular compensation. This is also the form you should give to your contracted employment attorney. Learn more in this FAQ provided by the IRS.

Protect your business.

Legal Disclaimer: This article is for informational purposes only and is not intended to constitute legal, accounting, or tax advice and it should not be relied on as such. Contact your own legal, accounting, and/or tax advisors to obtain advice before engaging in any transaction. No one from should act or refrain from acting based solely on information provided by Megastar HR without first engaging their own legal, accounting, or tax advisors.