During any given week in 2019, 44 million American workers, or 28.2%, were self-employed. 14% of the workers surveyed said being an independent contractor was their primary job. According to Forbes, several factors have contributed to the increase in self-employment amongst Americans, including slow growth in wages, rising housing and education costs, and cutbacks on traditional employee benefits, such as health care, due to increased costs. In other words, American workers have been forced to find additional ways to earn income.
Moreover, technological advancements have made it substantially easier to run a freelance business and allow self-employed workers to reach a broader consumer base and tap into different industries. With millions of Americans being unemployed due to the COVID-19 pandemic, the number of solopreneurs, freelancers, and independent contractors is likely to continue to increase.
With the rise of the gig economy and availability of independent contractors, many companies are considering hiring independent contractors rather than employees. However, the question has to be asked – when should a company use independent contractors and when should it use employees?
It is essential to understand what an independent contractor is and how it differs from having an employee to be able to make that decision.
What is an Independent Contractor?
Generally speaking, an independent contractor is an individual who has the right to control and direct how and when work with be completed. People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors.
However, these individuals are not the only ones who are eligible to be independent contractors.
In many jurisdictions, the law will define an individual's independent contractor status on a case-by-case basis. At the federal level, the Internal Revenue Service (IRS) considers three basic factors to determine the form of the business relationship between the employer and the worker, and consequently, the worker's classification. The IRS considers:
Behavioral control, specifically the degree of control the employer has over employee's work;
Financial control, including how the employee gets paid, whether the employee incurs profits or losses, and whether the employee simultaneously works for multiple parties; and
- The Type of Business Relationship, including the type of work the employee performs, the permanency of the relationship, and whether he or she receives any type of traditional employee benefits, such as vacation pay, pension plans, or sick leave.
Various states also employ tests to determine whether a worker is an independent contractor. For instance, in Colorado, a worker must be (1) free from control and direction in the performance of the service, both under contract and in fact; and (2) must be "customarily engaged in an independent trade, occupation, profession, or business related to the service performed" to be considered an independent contractor.
The Difference Between an Independent Contractor and an Employee?
How They Operate Differently
Independent contractors typically operate independent businesses and can perform work for multiple clients. They may have a standard billing rate or agree to a particular payment structure with an employer. Independent contractors typically provide any required tools or equipment necessary to perform their services. A clear example of this can be seen with ride-sharing companies like Uber, Lyft, and Via. In most states, Uber and Lyft drivers are classified as independent contractors and are permitted to work for multiple ride-sharing companies. Uber and Lyft do not provide vehicles to the drivers. The drivers use their own cars when working for Uber and Lyft.
As compared to an independent contractor, an employee typically works a full-time position with a single employer. The employer has complete control over the nature of the work performed, including the hours and location of work. Employees typically receive on-the-job training organized by the employer, whereas independent contractors may already have specialized expertise in a particular area or industry. Employees are often asked to perform a wide variety of duties and tasks. In contrast, independent contractors are only responsible for services outlined in an independent contractor agreement or some other document such as a statement of work.
Control Over Work
While employees and independent contractors typically receive instructional or managerial oversight, a company can only determine how an employee works, not how an independent contractor works. Independent contractors may hire their own employees, subcontractors, or partner consultants to help them complete work tasks without consulting with the company they contract to do business with. On the other hand, if a full-time employee wished to hire additional staff, he or she likely would be unable to make a unilateral hiring decision and may have to seek the approval of a hiring or human resources department.
Traditional full-time employees receive legal protections for unemployment, anti-discrimination, and workers' compensation. Furthermore, employees are eligible to receive company employee benefits, including health insurance, stock options, paid time off, sick pay, and retirement plans. Employers are not required to provide these same benefits to independent contractors. However, many do ensure that independent contractors have insurance requirements built into their contracts to safeguard against potential liabilities.
Worker classification is critical because it determines if an employer must withhold income taxes and pay Social Security, Medicare taxes, and unemployment tax on wages paid to an employee. It is equally as crucial for workers because independent contractors have certain obligations that a traditional full-time employee does not have.
How Independent Contractor Status Affects the Individual and the Company
For companies, the question as to whether the company should hire independent contractors or employees will come down to:
- How much control the company wants to have over the final work product; and
- How central the services are to the company's business.
Independent contractors have much more flexibility in how they perform work as compared to traditional full-time employees. This can be good for individuals but challenging for a company.
Typical independent contractors are usually their own bosses. They have the autonomy to dictate their hours and schedules and select what types of projects and work they want to take on.
However, one benefit of engaging an independent contractor rather than an employee is taxes. With independent contractors, a company simply issues a 1099 form (and any state forms) for services if in excess of $600 in the tax year. The IRS classifies independent contractors, for tax purposes, as “1099 employees.” This means that the companies the independent contractors complete services for do not withhold federal income taxes, Social Security taxes, and Medicare taxes from their payments.
In some jurisdictions, including Colorado, independent contractors are not included in the state workers' compensation and unemployment system because employer-sponsored workers' compensation insurance plans do not generally cover them.
While working with independent contractors could make sense in the short-term, if a company needs a specific service that is core to the business for a long-term project, it may work better to hire an employee. Since independent contractors can set their own schedules and do not work exclusively with one company, their availability may be limited in the long-term.
Should a company hire employees or utilize independent contractors?
This is a decision that will be driven the company's needs and where it is in its corporate lifecycle. While many small businesses hire independent contractors due to cost and simplicity, at some point, the needs of the company dictate full-time, dedicated employees. The benefit of having an employee is that company has the right to control the work product, the work hours and the manner in which the employee completes the work.
On the other hand, employees are a commitment and come with a host of regulations, both federal and state, on payments, wages or salaries, overtime, benefits, and taxes. Independent contractors allow a company to only pay for services needed, and allow a company the freedom to avoid certain employment and tax law responsibilities.
If the services you require are not central to your business, or are temporary in nature, you can likely engage an independent contractor and avoid the regulatory and tax stresses of having an employee. However, if the work is a long-term need that the company needs to control and is essential to a business, then hiring an employee is likely worth all of the legal obligations.
Are My Workers Considered Employees under Colorado law?
Under Colorado law, an individual is considered an "employee" unless and until it is shown that (1) the individual is free from control and direction in performing his or her services; and (2) the individual is customarily engaged in an independent trade, occupation, profession or business related to the work performed.
The employer typically has the burden of overcoming the presumption that the individual is an employee, absent a written contract or other agreement, which may shift the burden to the Department of Labor and Employment (CDLE).
If you've decided that you want to hire an independent contractor over an employee, the CDLE outlines the required elements of an independent contractor agreement that would overcome the presumption that the individual is an employee.
The contract must contain, and the parties must subsequently agree to, express provisions which provide that:
- The company does not and will not require the individual worker to work exclusively for the person or employer that the individual worker is performing services for. An exception to this is that the individual can choose to work solely for that person or employer for a finite period of time, which the parties must specify in the document.
- The individual is in charge of its own quality standard for the work product, not the company itself. The exception to this is that the employer can provide plans or specifications for the independent contractor regarding the work. However, the employer cannot oversee the actual work the worker completes or instruct the worker on how the worker will perform the work.
- The employer will not receive a salary or hourly rate but instead will receive a contract or fixed rate.
- The only way the company will be able to terminate the work the worker is performing during the contract term is if the worker violates a term within the contract or fails to meet the specifications or requirements that the company laid out in the contract.
- The company solely provides, at most, minimal training for the worker.
- The worker uses his or her own tools, and the company does not provide any benefits to the worker. The company may supply the worker with some materials and equipment, though.
- The worker has the freedom to choose when and where he or she completes the services. However, the company can provide the worker with a completion schedule which lays out the range in which the worker will complete the services. The company and the worker will usually agree on the timeline and the number of work hours and include them within the contract.
- The worker receives the payment under its trade or business name for the individual, rather than having checks and payments paid to the individual personally. Further, the company and the worker do not combine business operations in any way. Rather, the company and the worker maintain operations separately and distinctly.
In addition, the contract must contain a clear disclosure, in large boldface or underlined font, which states that “the independent contractor is not entitled to unemployment insurance benefits unless unemployment compensation coverage is provided by the independent contractor or some other entity, and that the independent contractor is obligated to pay federal and state income tax on any monies paid pursuant to the contract relationship."
The Colorado Supreme Court recently held that state courts will consider the totality of the circumstances to determine whether an individual is an employee or independent contractor, including contractual agreements and the nature of the relationship between the parties. As such, if you are interested in obtaining independent contractor status, it is critically important to ensure that you and your employer set clear employment parameters and that these are explicitly outlined in an independent contractor agreement or statement of work.
Contact an Experienced Law Firm
Making the decision to hire independent contractors or employees is an important decision that can affect your business's processes, policies, and legal implications. While independent contractor status certainly has its benefits, employment laws, labor laws, and tax laws are incredibly complex. There are substantial penalties at the federal and state levels, including monetary fines, if a worker is misclassified as an independent contractor instead of an employee, or vice versa.
An experienced Newburn Law attorney can assist you with better understanding the legal requirements of hiring independent contractors or employees, as well as with negotiating the terms of an independent contractor agreement or statement of work.
If you are considering hiring employees or independent contractors, contact us now to learn more about ways you can navigate these legal landscapes.
Amanda White Reply
Posted Mar 21, 2022 at 06:56:38
Thanks Ryan. Can you help to explain also the legal differences, pros, cons, etc. between going with an independent contractor vs. a firm for a service? Or is this legally pretty much the same? Here’s an example of what I’m referring to: https://lucrumconsulting.com/cfo-firm-benefits-vs-independent-cfo/
Ryan M. Newburn Reply
Posted Mar 21, 2022 at 08:28:17
Hi Amanda – thanks for the comment!
The analysis is the same but it is made somewhat easier by the executive nature of a CFO (i.e., a typical CFO will tend to control the time and manner of their work far better better than an administrative assistant for example). I’d love to discuss your specific situation and see if we can add better insight. Feel free to book some time with us (we don’t change for initial consultations).
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