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The Key Differences Between Employees and Independent Contractors


Bruce Burk
Business Consultant and Corporate Attorney
Contributor
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Are your workers independent contractors or employees? The answer to this question could have a significant impact on your finances as well as your liability in lawsuits. This article will discuss how to tell the difference between an independent contractor and an employee. It will also discuss how you can use both an independent contractor agreement and an employment agreement to make sure both parties are doing the right things to properly define the relationship. 

Why it Matters

The status of a worker as either an independent contractor or an employee matters for several reasons. First, an employer can be liable for the actions of an employee based on tort law if the employee does something to cause an injury to someone else. However, the employer will not be liable for the actions of a service provider. As far as tax implications are concerned, companies are usually required to pay payroll taxes (Social Security and Medicare taxes) for workers that are employees, but they are not required to do so for independent contractors. If you misclassify an freelancer who should have been marked as an employee, the IRS can come after you for the back payroll taxes that you owe. Moreover, employers are usually liable for workers' compensation benefits for employees, but usually, they do not have that responsibility for independent contractors. The bottom line is you want to clearly establish which worker falls under which category because doing this incorrectly can make a big dent in your accounts payable. That is why you want to have a service provider sign an agreement and an employee sign an employment agreement to act as a guidepost for the relationship between the parties. 

Behavior

The first step in telling the difference between these two is the level of control that the employer has over the employee's behavior. At common law, the definition of an employee had to do mostly with whether or not the employer had the right to control what the worker did. However, in contrast, an independent contractor gets to exercise more discretion over how he performs his duties. It is the employer's right to control how the employee performance his job which is more important than whether or not the employer actually exercises that right of control. Therefore, it is a good idea to define the specific ways an employee will be managed and directed in your employment agreement and indicate that the independent contractor will have wide discretion in accomplishing their projects in your independent contractor agreement. Please take a look at some of the Starting Business Agreements to see if they work for your business.

In analyzing whether a worker is an independent contractor or an employee, a court would look at factors such is the location of where the work is performed, the method that the worker uses to perform his task, whether or not he has assistance, or if there is a particular set of procedures by which the worker is to perform a task or a set of tasks. If the worker has a particular place where he is always working, such as an office, then it is more likely than he is an employee rather than an independent contractor. Your employment contract should lay out the locations where the work will be performed and whether the service provider can hire agents to complete the work. 

The more detail that the employer provides regarding procedures or instructions for how the worker will perform work, the more the relationship begins to look like that of an employer and an employee. Moreover, if the employer has an evaluation system by which they judge the employee on the specific objectives, then it is more likely that the worker is an employee and not an independent contractor. For example, if the employer has evaluation forms that are reviewed with the worker on a periodic basis then it is more likely that that work or is an employee. So, in your employment agreement, you should have language regarding how the employee will be evaluated on a periodic basis. Conversely, any employment contract for an independent contractor should not provide specific evaluation criteria. 

Also, if the employer provides specific training classes that give the employee written procedures by which they are to do their job, requires them to obtain certifications, or pays for them to attend training classes then the worker is likely an employee. On the other hand, an independent contractor will usually be fully qualified at the time they are hired. The fact that the employer is in an active process of training the worker means that it is more likely that they are an employee. Make sure to put in your employment agreement that any independent contractors will be responsible for their own training. Take a look at all the agreements Starting Business offers to see if it works for your particular situation. 

The length of employment can also be a determination of a worker's status. If someone is employed for only a few weeks, then they are more likely an independent contractor. However, you can maintain your independent contractor status and work for the same employer for many years. You should have the proper employment agreements or independent contractor agreements that address the factors that have listed so that you can clearly identify which category you fall in. Review your agreements to make sure they spell out the length of employment. 

Contract With Independent Contractor

A document used for an individual who wishes to work for a company as an independent contractor.

Financial

The idea of control can also be expressed by the employer in the form of financial arrangements. Usually, independent contractors are required to purchase the equipment necessary to perform their duties themselves. In contrast, employees will likely be able to have access to equipment and tools that are owned by the employer. However, there are no specific dollar amounts or percentages by which to measure how much an independent contractor would have to spend to maintain that status. Therefore, you want to make sure you do not purchase equipment for a worker who is an independent contractor. Rather, have it purchased for your company and give the contractor a license to use it. Check out the employment contracts here on Starting Business so that you can clearly define the employment relationship on paper. 

Independent contractors are not governed by federal or state minimum-wage laws and are not entitled to overtime for working more than forty hours of hours per week, while employees have the right to these benefits. Employees may also be eligible to join a union whereas independent contractors are not. Contractors are also usually not protected by anti-discrimination laws, but employees are. Lawsuits related to anti-discrimination or violations of overtime law can be very costly for companies. This is why it is important to review your employment contractors and how your employees are managed to avoid a lawsuit.

Expenses can also play a key factor in whether or not someone is an employee or an independent contractor. The latter will likely have to spend a significant portion of money incurring expenses for any particular set of work. Employees can also encourage reimbursed expenses, but a worker starts looking more like an employee if the employer is reimbursing the employee for these expenditures. Agreements on expenditures are something that you can put in your employment contract so that you can identify ahead of time the expenses that a worker is going to have themselves and what the employer is going to pay for. Whereas your independent contractor agreement can specify that the contractor will be responsible for absorbing any expenses. 

The method of payment is likely one of the greatest- if not the greatest- factor by which a worker's status will be determined. Employees often have a set amount of payment that they receive on a schedule. However, in contrast, independent contractors are usually paid by the job on a flat fee basis for work performed. If you're working with independent contractors, your agreement should explicitly specify that the contractor is liable for any losses that occurred to tools, equipment, and unreimbursed expenses. Employees usually will receive health or disability benefits from their employer while independent contractors generally do not receive said benefits. Take a look at the employment contracts that Starting Business offers to see if they address how workers will be paid. 

The opportunity to make a profit or loss for work performed is something more commonly known to independent contractors, whereas employees are more likely to just simply receive their salary or hourly wage regardless of how they perform their work. For example, if you hire a contractor to mow your lawn and a flood destroys his tractor, that loss will be suffered by him alone and not the person who hired him. Make sure to put in your independent contractor agreement how they will be paid so there is a clear distinction that they will receive no interest in the business. 

Type of Relationship

The relationship status as it's perceived by both the worker and the company can also define whether or not the worker is an employee or an independent contractor. This is also something that can be clearly laid out in an employment agreement or an independent contractor agreement. The best way to spell out the relationship is to use a written contract so that way if a worker goes outside what they are supposed to do you can take corrective action. 

Although a contract is not going to be the sole determination of your work behavior, it can be used as a tool between the employer and the worker to define the roles ahead of time, so that an independent contractor does not later develop characteristics of an employee. Also, a contract can legally bind a worker to be authorized to perform only certain tasks in a specific way and in case they do something outside those tasks would be a breach of contract. In this way, you would have an action in contract law should the independent contractor do things intentionally to make himself into an employee.

Another thing that the court would look at in determining the status of a worker is whether or not they are performing tasks which are an integral part of the business. For example, if you're operating a restaurant, the chefs that you employ are likely playing an integral part of the business because you cannot serve food unless you have chefs to prepare it. For example, in an engineering firm, the engineers that work there would be performing an integral part of the business and, therefore, will more likely be considered as employees. This means you should only hire independent contractors to work on items that are not business critical, which you can outline in your independent contractor agreement, too.

Independent Consultant Agreement by Hiring Firm

An Agreement used by the hiring company when looking to hire an independent consultant to perform specific consulting services at the firm.


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Bruce Burk Business Consultant and Corporate Attorney
Bruce Burk is an experienced business consultant and attorney who's worked for billion dollar companies. He has acted as a consultant to many companies creating business plans, finding seed money, creating marketing campaigns, developing corporate strategies, and creating a plan for businesses to grow. As an attorney, Bruce specializes in business litigation, corporate, and real estate law. He helps structure new companies, negotiate contracts, and protect his client's interests.
Bruce Burk is an experienced business consultant and attorney who's worked for billion dollar companies. He has acted as a consultant to many companies creating business plans, finding seed money, creating marketing campaigns, developing corporate strategies, and creating a plan for businesses to grow. As an attorney, Bruce specializes in business litigation, corporate, and real estate law. He helps structure new companies, negotiate contracts, and protect his client's interests.

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