Employee or Contractor? How to Properly Classify Your Team


It’s time to hire some help. Growing a team is a big step that makes many entrepreneurs full of fear and dread because of the idea of managing people and the paperwork that goes with it.

The upside is, with help, you can lighten your workload and, in most cases, help more people with your product/service! To help you get started, we’re going to look at which type of hire – employee or contractor – makes the most sense.

Hiring an independent contractor often seems like the obvious choice. In this case, your company won’t have to pay payroll taxes, provide workers’ compensation, or pony up for space or equipment.

Sounds like the perfect solution.

It may well be. However, the difference in classification can get a little muddy.

Consider this: Payroll taxes alone account for a third of the tax revenues that the government collects each year. According to a report by the U.S. Treasury Department, worker misclassification costs the government billions of dollars, which explains why the IRS takes this very seriously. In fact, they take it so seriously that they have created a strict three-category approach to help businesses distinguish between independent contractors and employees.

  1. Behavioral Controls – This has to do with the type of instruction given to the worker about when, where, and how they are to perform the work, whether or not supplies are provided, and so forth. It also covers whether training is necessary for the job. (Hint: If you are controlling the worker’s schedule, work environment, etc., the worker is being treated as an employee and must be paid as such.)
  2. Financial Controls – This relates to the expenses of the worker, whether or not the individual can and does work for others, as well as how the worker is paid. (Hint: If the worker pays his/her own expenses, works with other clients, and is paid either a flat, project-based fee or a monthly retainer, then this person is operating as an independent contractor.)
  3. Type of Relationship – This has to do with the type of contractual agreement in place, types of benefits, if any, duration of the agreement, and most importantly, how significant the role of this worker is to the daily functioning of the business. (Hint: If the individual is an essential member of the team with no designated timeline for the work he/she is doing, this person might need to be classified as an employee.)

Let’s briefly explore this a little further.

A Side-By-Side Comparison

Independent ContractorEmployee
Flat fee for specific tasks or jobsHourly wage
Pays own task- and job-related expensesEmployer pays task- and job-related expenses
Cannot be fired, but can agree to end contractCan be fired
Contracted for a task or job for a specific period of time with a beginning and an end dateHired with the intention to work for an indefinite period of time with no specific end date
Does not do work that is integral to your business, but adjunctive to your businessDoes work that’s integral to your business
Pays own taxesCompany withholds taxes

Given that employee misclassification is a huge issue that can lead to fines for failing to follow the necessary protocol, it is essential that you are clear about the role and overall scope of each newly hired employee or contractor. It’s important to assess whether you want this person to be a part of your team or simply to help you complete a specific project. It is also possible that a person begins with your company as a contractor, and after proving to be a great asset, moves into part- or full-time employment.

Your Turn!

If you’ve already hired or contracted with people, or you’re about to, go over the checklist to make sure you’re in compliance.

Have a question about this topic or anything else?

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