Independent Contractor vs Employee: More Contractor Hiring Makes the Distinction Crucial

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By Caleb Groos on April 02, 2009 12:27 PM

Small businesses are using a rising percentage of independent contractors. Currently, just under 4% of workers used by small businesses are independent contractors. Though important before, the line between classifying someone as an employee versus an independent contractor has become even more crucial.

As Small Business Trends describes, SurePayroll tracks the payroll trends each month for the 25,000 small businesses it serves. Each month's Small Business Scorecard includes a Contractor Index -- the percentage of independent contractors versus employees used.

As of the end of March, the Contractor Index reached 3.88, meaning that almost 4 of every 100 workers engaged by small businesses were independent contractors. This is up from 3.82 the month before, and also the highest Contractor Index measured yet by SurePayroll.

The increased use of independent contractors means the notorious line between contractor and employee is even more important. Unfortunately, different government agencies use different criteria for deciding when someone is an employee versus a contractor. Because tax liability looms as perhaps the most feared ramification of misclassifying a worker, here is a brief explanation of how the IRS makes the call.

To determine whether a worker is an independent contractor, the IRS looks at the extent to which the hring company has the right to direct and control the way the work is done.

Factors making the IRS less likely to classify the worker as an independent contractor include:

  • ability to be fired at any time by the hiring firm
  • being paid by the hour
  • receiving instructions from the hiring firm
  • receiving training from the hiring firm
  • working full time for the hiring firm
  • receiving employee benefits
  • having the right to quit without incurring liability, and
  • providing services that are an integral part of the hiring firm's day-to-day operations.

Factors making the IRS more likely to find the worker an independent contractor include:

  • ability to earn a profit or suffer a loss from the activity
  • furnishing the tools and materials needed to do the work
  • being paid by the job
  • working for more than one firm at a time
  • investing in equipment and facilities
  • paying his or her own business and traveling expenses
    hiring and pays assistants, and
  • setting his or her own working hours.

The cost of misclassifying an employee as an independent contractor can be huge, including owing the IRS all back taxes plus a penalty between 12% and 35% of the tax owed.

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