Independent Contractor or Employee? Know the Financial Rules


Knowing the law is critical for employers when determining employment status. Today many companies and workers prefer contract employment to permanent, traditional employment. While this system has advantages for both employers and workers, it also opens the door for potential abuses. This can cause conflict on both sides. Understanding the rules upfront can save valuable resources including time and money.
There are three areas of criteria to consider when determining whether a worker is an independent contractor or an employee. The three areas are 1) Financial, 2) Behavioral, and 3) Type of Relationship. While these criteria provide guidelines, it is important to evaluate each situation and ensure that each worker's status is appropriate for the work performed. Here we will take a look at the financial factors to consider when evaluating a worker's classification.
Financial control refers to facts that show whether the business has the right to control the economic aspects of the worker's job. Asking the right questions about financial control can help in differentiating between contractors and employees. Contractors and employers should ask: Has there been a significant investment by the worker? There are no exact amounts that determine significant investment, but a contractor often invests in equipment and supplies. However, some occupations, such as construction, require workers to spend thousands of dollars on equipment and still classify them as employees.
Expense reimbursement is another factor that helps determine contractor versus employee status. Contractors are more likely to have unreimbursed expenses than employees. Ongoing costs that are fixed and are incurred whether work is currently being performed or not, are especially important. However some regular employees have unreimbursed costs.
The opportunity for profit or loss is another important factor. Workers that have significant investment in tools or equipment are at greater risk for losing money. If expenses exceed income, they incur losses. The possibility of incurring a loss indicates that a worker is possibly and independent contractor.
An independent contractor is generally free to seek out business opportunities. Contractors often advertise, maintain a visible business location and are available to work in the relevant market. This is generally not the case for employees, who may have agreements with employers not to be otherwise employed.
Finally, the method of payment is generally an indicator of employment classification status. An employee is usually earning a regular wage for an hourly, weekly or other time period. An independent contractor is usually paid by flat fee per project. However, it is not uncommon for some professions to pay contractors hourly.
Contractors must file a 1099 form with each of their clients. This form is for anyone who is self-employed and it is necessary when the contractor earns at least $600 from a client. The form reports the contractor's earnings for each client. According to the Internal Revenue Service, contractors are responsible for paying taxes on their profits, not the clients that hired them.
According to Inc Magazine, the IRS suspects 15 percent of workers are misclassified. Microsoft lost a classification case because they treated temporary contractors as regular, full-time employees. Because the workers were told to work on-site, under supervision, at regular times, Microsoft paid penalties for misclassification.