Employee or Not? Independent Contractors Demystified

You might think converting a regular employee to an independent contractor is as simple as removing them from the payroll and handing them a 1099. They might be cheaper than an employee in the short term, but you could open yourself to a variety of compliance issues.

The IRS has specific requirements for independent contractors. Three key categories allow for the classification of an independent contractor. If the relationship between the employer and the individual does not meet the specified requirements, the employee is likely misclassified.

California adopted additional legislation in 2019 to define and regulate employers’ use of independent contractors. Assembly Bill 5 (AB 5) addresses the employment status of workers and requires California employers to complete one of two tests when deciding if an individual is an employee. The first test is called the ABC test. It asks questions relating to the employer’s control over the worker’s day-to-day responsibilities, the scope of work, and exclusivity. In addition to the ABC test, certain industries can use a multi-factor assessment called the Borello test. However, the basic guidelines for an independent contractor remain consistent no matter what test you use.

Consider these factors before classifying a worker as an independent contractor:

Day-to-day Responsibilities

If you have a start time, end time, and scheduled break times for your independent contractor, they might be an employee. Independent contractors can be required to meet deadlines and come to some appropriate meetings, but they are otherwise free to structure their day to their own needs.

Work Equipment

An independent contractor is responsible for their equipment and any business expenses. They buy their own power tools, staplers, laptops, etc. For example, a designer working on a project as an independent contractor would use their own laptop and drafting tools.

Benefits

In addition to being responsible for their own equipment, an independent contractor must also fund their own healthcare. Typical employment benefits such as healthcare, performance appraisals, bonuses, paid time off, etc., help define what makes an employee. If you offer your independent contractor the same benefits as an employee, they are likely misclassified. Independent contractors should have a written contract spelling out the start and end dates of the project, expectations, and pay.

Exclusivity

Independent contractors may have multiple clients and work on several different projects. Asking an independent contractor to sign non-compete agreements or otherwise limiting their work with other clients will spell misclassification. Employers may set the parameters of a project, but they cannot dictate how the independent contractor completes their tasks. The work performed by the independent contractor should be outside the course of the company’s business in an independently established trade, occupation, or business.

Misclassification is a risk for employers. The IRS and Department of Labor (DOL) audit some industries more often. Historically, the drywall, property management, landscaping, security, restaurant, cleaning, and salon industries have a higher chance of being audited. Employers who misclassify workers may have civil penalties between $5,000 and $25,000, in addition to tax penalties. California employers who misclassify employees also open themselves up to investigations by the California Department of Industrial Relations (DIR) and the Employment Development Department (EDD).

Employers can partner with Emplicity’s Human Resources experts to reduce their risk of costly audits, penalties, and lawsuits resulting from misclassifying independent contractors. Our full-service HR and risk management team can help employers remain compliant.