Hiring people is one of the most important things you do as a business owner and often there can be some gray area as to whether a person is an independent contractor or an employee. This distinction is very important and can be very costly in the form of penalties and fines, if the wrong classification is made.
In determining whether an individual is an employee or contractor, it is important to examine all the factors that provide evidence of the degree of control and independence.
Control and independence can be broken down into three categories:
- Behavioral Control
- Financial Control
- Type of Relationship
Behavioral Control refers to whether the business has a right to direct or control how the work is performed. If the business has the right to direct and control the work, then the individual is an employee. What matters is that you have the right to control the details of how the work is performed. Factors determining behavioral control include the type of instructions given, the degree of instruction, whether there is an evaluation system for the work, and whether any training was given to the individual.
Financial Control is whether the business has the right to control the economic aspects of the worker’s job. These factors include the following:
- Significant investment – independent contractors often have a significant investment in equipment
- Unreimbursed expenses – independent contractors are more likely to have unreimbursed expenses
- Opportunity for profit or loss – having the possibility of incurring a loss indicates the worker is an independent contractor
- Services available to the market – independent contractors are generally free to seek out business opportunities
- Method of payment – independent contractors are usually paid a flat fee by the job
Type of Relationship relates to how the business and individual perceive their relationship to each other. These factors include any written contracts between the two parties, whether any employee benefits are being provided, the duration of the relationship, and whether the services provided are a key activity of the business.
There are no set number of factors that “makes” the worker an employee or a contractor, and no one factor stands alone in making that determination. Businesses must weigh all of these factors together to determine whether an individual is a contractor or an employee. Consult your CPA for more guidance in making this important decision.