Independent Contractor FAQ

By Marie-Joelle C. Khouzam

What is the difference between an independent contractor and an employee?

Generally, an independent contractor works with significant autonomy and can control or direct the means and methods of accomplishing a job. A contactor can work for multiple entities simultaneously, can set his/her own hours, utilize whomever he/she chooses to work on the job, and is generally paid by the job rather than by the hour or week. A contractor is generally expected to provide and be responsible for the cost of his/her own tools, transportation, training, and other expenses. By contrast, it is said that an employee works for one “master”, who is entitled to control what will be done and how it will be done.

The 20-factor test formerly used by the IRS to determine the extent of control has been streamlined to three main groups: behavioral control, financial control, and the type of relationship of the parties.

Behavioral control refers to whether the entity has a right to direct and control how the worker does the task for which he/she is hired, including the type and degree of:

• Instructions. the more instruction that is given, the less independent the worker appears to be. For example:
  • When and where to do the work
  • What tools or equipment to use
  • What workers to hire or to assist with the work
  • Where to purchase supplies and services
  • What work must be performed by a specified individual
  • What order or sequence to follow

  The amount of instruction varies by job. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work is done.

• Training. An employee may be trained to perform services in a particular manner, generally provided by the employer at its cost.

Financial control refers to whether the business has a right to control the business aspects of the worker's job, including:

• Expenses. Independent contractors are more likely to have unreimbursed expenses than are employees.
• The extent of the worker's investment. An employee usually has no investment in the work other than time. An independent contractor has usually made a significant investment in his or her business. However, a significant investment is not determinative of independent contractor status.
• The extent to which the worker makes services available to the relevant market. An independent contractor is generally free to seek out business opportunities. They often advertise, maintain a business location, and are available to accept multiple projects simultaneously.
• How the business pays the worker. An employee is generally paid a regular wage for an hourly, weekly, or other period of time. An independent contractor is usually paid a fee by the job.
• The extent to which the worker can realize a profit or loss. Since an employer usually provides employees a workplace, tools, materials, equipment, and supplies needed for the work, and generally pays the costs of doing business, employees do not typically participate in the profit or loss of the business.

Type of relationship refers to factors including:

• Written contracts describing the relationship the parties intended to create. While this factor may carry the least amount of weight on its own, the written contract illustrating the parties’ intent can make a difference.
• Whether the business provides the worker with fringe benefits: An independent contractor is generally not entitled to receive benefits ordinarily offered to employees.
• The permanency of the relationship. If a company engages a worker for an indefinite period of time rather than for a specific project or period, this may be evidence of an employer-employee relationship.
• The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker provides services that are a key aspect of the company's business activity, it is more likely that the company will have the right to direct and control his or her activities.

What are the tax consequences of being an independent contractor?

Generally, employers withhold income taxes, pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. However, no withholdings or taxes are taken from payments to contractors. Companies issue contractors 1099 forms, but send W-4s to employees. Copies of both are sent to the IRS.

If an employer incorrectly classifies an employee as an independent contractor, the employer may be answerable in an audit or to legal claims brought by the worker.

Is there a standard written contract for independent contractors?

No. However, having a written contract with independent contractors is critical to documenting the parties’ intent when it comes to rights and obligations.

What are the benefits and risks of hiring independent contractors?

Benefits

• Businesses may be able to save money that they would have otherwise paid for benefits, payroll taxes and other fringes by hiring independent contractors.
• Hiring independent contractors may reduce exposure to legal claims that can only be brought by employees.
• Independent contractors provide flexibility that can't be obtained with employees: contractors need not be hired for a fixed or indefinite duration, and they pay for their own training and expertise.

Risks

• The legal risk of misclassifying employees as independent contractors is significant if the terms of the relationship are not properly planned in advance.
• The financial consequences of misclassifying can include audits that result in IRS back taxes, interest, and penalties; claims for employee benefits; claims for overtime, and other legal issues.