Should My Company Have Independent Contractors or Employees?

Of all the challenges an entrepreneur will face during the life cycle of a venture, one of the most difficult is attracting and retaining talent. Not only do entrepreneurs need to determine how to compensate and incentivize workers, they also have to decide whether to hire independent contractors or employees. While an independent contractor and an employee may receive the same compensation for the same work, the legal differences between the two types of workers can have serious consequences.

There are a number of legal tests used to determine which classification a worker falls into, and the location and requirements of the job may affect which legal rules apply. Titles, alone, do not control. Regardless, all jurisdictions in the US apply some form of the “common law control test” and “economic realities test” to distinguish between independent contractors and employees. The table below applies these to help in determining which type of worker is right for your business. If you answer “yes” to most of the questions in a column, that is likely the type of worker you should have.

The outcome of the test is one of several factors entrepreneurs should consider when determining a worker’s classification, including those outlined below.

• Independent contractors are often an attractive option for a start-up venture because of the reduced administrative costs associated with their use. Bearing employee-related costs like benefits, tax withholdings, and workers’ compensation insurance are easier with scale. As a result, satisfying general staffing needs by hiring employees may only be efficient for more mature businesses. However, while control over what the worker does and how they do it is critical, hiring an employee may make the most sense even for the earliest start-up venture.

• Forms 1099 and W-2 are the tax documents that separate these workers. Independent contractors use Form 1099 and employees use the W-2. The distinction is important because an “independent contractor,” by name, can be re-classified as an “employee” by the state or U.S. Department of Labor or the IRS. If this happens, misclassified workers can sue for denial of benefits, including overtime pay, health insurance, and minimum wage. The company will also have to pay for Social Security, Medicare, and unemployment compensation taxes.

• Other significant issues with classification involve Form I-9 and immigration law, ERISA and employee benefit plans, workers’ compensation and tort liability, whether the business owner can be personally liable for claims, and the aforementioned administrative burden that comes with treating workers as employees.

California employers should be mindful of the recently passed legislation aimed at worker classification in the gig economy which makes it more difficult to classify workers as independent contractors. Affected businesses should be certain they have correct worker classifications prior to when the legislation goes into effect on January 1, 2020.

If you are unsure whether a current worker is a 1099 independent contractor or a W2 employee you may want to file a Form SS-8 with the IRS. The IRS will then decide how the worker should be classified. This process can take up to six months, but may be helpful if you frequently hire for the same kinds of roles.

Consult with an attorney to determine the kind of worker your business needs and how you can structure the engagement to achieve the worker classification that is best for your business. An attorney can also assist with the administrative burden involved in hiring your first W-2 employees by helping to identify and connect you with the right resources.