The difference between employees and independent contractors


*Updated with video – see below*

What if you didn’t have to pay employment tax, worker’s comp, unemployment, payroll processing fees, and all of the other costs that go along with having employees?

Sounds good right?

It’s a risky bet that many employers have taken in recent years – classifying all or some of their employees as independent contractors in order to avoid employment costs.  Maybe it was advice given by their accountant or just a family friend.  Maybe they saw one of their competitors reclassify all of their employees and it seemed like a smart idea.

Whatever the reason the number of employees misclassified as independent contractors has risen significantly in the last several years. The federal government has taken notice. In late 2011 the U.S. DOL issued a memorandum of understanding with the I.R.S.  stating that they would share information and work together to reduce the incidence of misclassification of employees and the employment tax portion of the “tax gap”.

There are many risks associated with misclassifying your employees as independent contractors but usually the most costly is unpaid overtime wages. What happens is this:

You decide to hire only independent contractors to work for your company.  Since you incur very few costs by doing this you can afford to pay these people at a much higher rate than if they were employees. So you hire 30 people and pay them $20 per hour rather than the $14 per hour that you could pay an employee who did the same job. Since they aren’t employees they aren’t covered by federal or state labor laws so all of your employees work 60 hour weeks and you don’t pay them any overtime.  And everything is going great…

                Then one day the U.S. Department of Labor comes knocking and says that your company is under investigation.  During the investigation they determine that the people you had classified as independent contractors are actually employees of your company and subject to federal labor laws. They charge you overtime owed for the last two years (20 overtime hours per week * $20 per hour * 30 employees * 0.5 * 104 weeks = $624,000) and they charge you liquidated damages for the unpaid wages owed (an additional $624,000).  And voila! you have a $1,248,000.00 bill due in 90 days.

Labor Brain Inc. employees have investigated many employers who misclassified employees as independent contractors and the results were not pretty. We can tell very quickly whether or not your workers are correctly classified. We think the best rule of thumb is to answer these questions:

  1. Are your independent contractors doing the same job as any of your employees?
  2. Do you only have independent contractors?

If you answer yes to either of these questions you are probably misclassifying employees and should fix it immediately to avoid severe problems down the road.

The complete test of whether a person is an employee or an independent contractor is a little more complicated and includes analyzing several employment related factors.  Listed below are the factors used by the U.S. Department of Labor. The I.R.S. has its own list of factors as do many state departments of labor but it all boils down to the same general theme. Are they working for you or are they working for themselves?

1) The extent to which the services rendered are an integral part of the principal’s business.

2) The permanency of the relationship.

3) The amount of the alleged contractor’s investment in facilities and equipment.

4) The nature and degree of control by the principal.

5) The alleged contractor’s opportunities for profit and loss.

6) The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.

7) The degree of independent business organization and operation.

Check out our YouTube Video on this topic!

We hope you found this week’s tip helpful and informative. Please pass it along to anyone you think might be at risk as a result of employee misclassification. Follow us on facebook to get the next Tip of the Week on your newsfeed!


–    By Kalen Fraser

The Labor Brain Inc. is not a law firm and its employees do not practice law or provide legal services.  The information provided on our website,  in email correspondence with representatives of The Labor Brain, and at outreach events is for informational and educational purposes only.  The information provided is not a substitute for the advice of an attorney.