Accurate worker classification is a big deal. Full stop. Still, in light of a recent federal ruling, making the right decision is about to be more important than ever. Making the decision to classify a worker as in independent contractor versus an employee requires an in-depth understanding of the differences. The decision affects more than a business’s budget: It is crucial for legal compliance and operational success as well.
Contract Worker Versus Employee: What’s in a Name?
From the business’s perspective, the name a worker gets might not be too important as long as the worker gets the job done. From the Department of Labor’s perspective, the name (i.e. classification) of a worker is important enough to put federal attention toward getting it done right. Let’s start with the definitions.
Independent Contractors are self-employed contract workers. These individuals are contracted to perform work for another entity as a non-employee. They have the freedom to determine how to complete tasks, set their hours, and may work for multiple clients simultaneously. Contractors submit invoices for their services and are responsible for reporting their own taxes and procuring their own health insurance, retirement plans, and more.
Employees, on the other hand, work directly for a company and are under the company’s control in terms of how, when, and where their work is completed. Employees are on the company’s payroll, and the employer withholds taxes, pays wages, benefits (such as health insurance and retirement contributions), and adheres to labor laws (overtime, minimum wage, etc.).
So What? What Does That Mean in Practice?
From the business’s standpoint, the main implications of the independent contractor classification are the legal and tax obligations (including risk and liability matters), the level of control, and the cost and commitment.
Employers have more legal, tax, and compliance obligations towards employees, including withholding income taxes, paying Social Security and Medicare taxes, and complying with labor laws. Independent contractors handle their tax obligations, reducing the administrative burden on businesses.
Employers also have more control over employees, dictating their work hours, location, and methods. Contract workers have more flexibility, as they control how they complete their work, though they must meet the terms of their contract.
Hiring an employee is a long-term commitment that includes salary, benefits, and other compensation. Contract workers may have higher hourly rates, but the overall cost can be lower since the company does not provide benefits or pay employment taxes.
Which Classification Costs a Business More Money and Resources?
While the general viewpoint is that employees are more expensive and carry a greater administrative load than contract workers, misclassifying an employee as an independent contractor can turn that so-called “formula” on its head because mistakes can lead to legal and financial penalties right along with an administrative headache to correct the mistake. It’s vital for businesses to correctly classify their workers based on federal and state laws both for legal reasons and business practicalities.
Main Aspects to Consider for Worker Classification Decisions
When determining whether to hire an independent contractor or an employee, companies should consider the following:
Control: Do you need to control not only the outcome of the work but also how and when the work is done? If so, an employee may be the right choice.
Duration and Scope: Is the work project-based or temporary, requiring specialized skills not available within your organization? Contract workers might be suitable. If the work is ongoing and central to your business, hiring an employee could be more beneficial.
Financial Considerations: Evaluate the total cost of employment, including benefits and taxes, against the cost of hiring a contractor. Consider your budget and the nature of the work.
Legal and Tax Obligations: Understand the legal distinctions and tax implications of hiring employees versus contract workers. Ensure compliance with IRS guidelines and local labor laws.
Risk Management: Assess the risks involved in worker misclassification. Consider the consequences of legal challenges or penalties.
Operational Needs: Determine if the role requires someone who will integrate into your company culture and collaborate closely with your team. Employees might be more suitable for roles that require a high degree of integration and long-term development within the company.
Flexibility: If your business needs fluctuate or you require specialized skills for short-term projects, contract workers offer the flexibility to scale work up or down as needed without the long-term commitment of an employee.
Benefits and Perks: Decide if offering benefits and perks is essential for the role you’re looking to fill. These are typically reserved for employees.
If your internal departments don’t have the administrative bandwidth or level of expertise to handle these decisions with confidence, consider engaging a partner whose core business model is to take on classification decisions as well as much of the related risk.
The Bottom Line
The decision to hire independent contractors or employees hinges on a variety of factors, including control, cost, flexibility, and legal obligations. Businesses must carefully assess their operational needs, project scope, and the level of commitment they can offer to make an informed decision. Correctly classifying independent contractors is not only a matter of legal compliance but also aligns workforce strategy with business goals, ensuring long-term success and sustainability.
