Employee v. contractor: Which is right (and legal) for your business

Businesses are constantly evolving how they operate in order to meet the fast-paced changes coming from customers and the marketplace. Further, individuals are increasingly taking advantage of the income they can earn from the gig economy. These factors have more businesses looking for contractors and more workers looking for a contracting arrangement than ever before.

The use of contractors versus hiring employees is a frequent question that business owners bring to their CPA. Misclassifying employees and contractors can result in serious issues with the Department of Labor (DOL) and a significant financial risk, and businesses should not take chances. Common inappropriate classifications of employees as contractors include:

  • The worker wants to be treated as a contractor
  • The organization has a signed contract with a service provider
  • The worker does assignments sporadically or inconsistently or is on-call
  • The worker is virtual or remote

In order to determine what is right, and legal, for the business, there are a series of stress tests the business should consider. Here is a simple example.

Question Yes No
Is the individual directed on when, how, and
where to perform the work?
Must the individual follow a particular method when
performing the work?
Is the employee evaluated on skills (Yes) or
results (No)?
Does the worker use company-provided tools?
Does the company pay expenses?
Is the worker paid by the hour, week, or month
vs. lump sum?
Is the worker offered benefits such as insurance,
pension, or PTO?
Is the relationship with the worker and the
company indefinite?
Is the worker performing key business activities/
are they vital to the regular business of the company?

Generally, more responses in the ‘Yes’ column results in the worker being treated with employee status, and more ‘No’ responses are considered independent.

This is not a catch-all or fail-safe test but is a good precursor to making hiring decisions. Additional factors to consider:

  • The nature of the contract and how it is written: Contracts stating a worker is an employee or independent contractor are not enough to determine the worker’s status in the eyes of the DOL.
  • Marketing activities: Employees do not market their services on a regular basis, whereas independent contractors are likely to.
  • Profit and loss: Independent contractors incur a profit or a loss. The risk of loss may be the result of investments in equipment or due to other expenses.
  • The job type and the nature of the business trade: For example, companies providing web solutions looking for a programmer would hire that candidate as an employee. But, if they were looking for assistance with their marketing and content, that person could be classified as a contractor.
  • DOL classifications: The DOL can also change the classifications of your contractors, subjecting you to serious fines and tax issues. Staying on top of DOL activity in this area is essential if you mean to engage contractors.

For growing businesses looking to increase personnel, consider a hybrid approach where possible. Hire employees when the role is critical to the business’s functioning and output for clients and hire a contractor for special or occasional projects.

Determining whether a worker is a contractor or an employee is more of an art than a science, and if you get it incorrect, you put your business at serious risk. Work with your business advisors to determine what is right for you and to ensure you’re documenting all activities properly in the event of a DOL audit.