Any growing business will inevitably be faced with decisions about hiring help, but how do you know whether to hire an employee or an independent contractor?  Navigating the decision requires understanding that the relationship between a business and its workers is complex and requires careful thought and often professional guidance.

Having employees on the payroll requires compliance with Washington and federal laws for worker protection and taxation purposes.  Businesses must carry workers’ compensation insurance, provide health insurance, and allow for family medical leave under certain circumstances for employees. You must also pay for unemployment benefits. On the other hand, if your workers are independent contractors, instead of employees, you are relieved of having to provide these and other benefits, and you don’t have to worry about withholding taxes and other deductions from their checks.

The question is, how do you know if you should classify your workers as contractors or employees? The answer is not always black-and-white, and there are risks and benefits to both.  It is important to take this question very seriously and to seek appropriate legal advice if you are uncertain of the answer. Misclassifying your employees can lead to very serious consequences, including penalties, back taxes, and fines.

The complex definition of an employee

The two federal government entities most concerned with how you classify your employees are the Internal Revenue Service and the U.S. Department of Labor. The IRS wants to make sure you are deducting income taxes from employee checks and paying the government its due.  In contrast, independent contractors do not have income taxes taken from their payroll.  The Department of Labor wants to make sure you are paying a fair wage, including the appropriate overtime rate, which generally applies to employees but not to contractors.

You may have a contract that describes your workers as “contractors”, but the government says this is not enough to establish an independent contractor relationship. According to the IRS, each case has its own unique factors, but in general, your workers are deemed to be employees if the following factors apply:

• You have extensive control over the workers, including instructing them on when, where and how they do their work.
• You supply training for the job.
• You monitor and evaluate the performance of the workers.
• You provide the tools the workers need for the job and require them to use those tools.
• The workers work exclusively for you and not for others doing a similar job.
• The job your workers do is directly related to the substance of the work your company does.

The IRS applies a general rule to classify independent contractors as those who perform services independently – meaning the business controls and directs only the result of the work, not how or when it will be performed.  An independent contractor is deemed to be self-employed from an IRS taxation standpoint.

An employee on the other hand is categorized by the IRS as someone who performs services under the direction and control of an employer – the business retains the legal right to control the details of how the services are performed.

The IRS definitions seem simple, but the Department of Labor has its own method of defining an employee versus a contractor, and these regulations change quickly and often. Of course, there are state agencies as well that govern employment relationships, such as the Washington Department of Labor & Industries and the Employment Security Department, which also have tests of their own differentiating employees from independent contractors.  Each agency defines workers according to their own criteria and the status of a worker is determined by those criteria, not by the agreement between the employer and the worker.  Sometimes the language and tests used by the various agencies can be confusing and contradictory, even for the savviest business owner.

If you are unclear about how to classify your workers, you may benefit from obtaining legal counsel to assist you in your determination.  Misclassification can be costly and time consuming to resolve after the fact.

Cap City Law serves business owners throughout the South Puget Sound with legal guidance on independent contractor and employee relationships and many other legal issues facing businesses.  The capable attorneys at Cap City Law are prepared to work through all the nuances with you to ensure you are protected.  Give us a call today at (360) 742-1335