Highlights
- Classifying workers correctly is crucial to ensure compliance with labor laws and tax regulations, and to pay employees accurately.
- The risks of misclassification involve significant legal and financial consequences for businesses.
- At Access Point, we provide HR solutions for small and medium-sized businesses, helping you protect your business and minimize the risks of penalties and litigations. Contact us to learn how to stay compliant.
Misclassifying workers in the U.S. can have legal and financial consequences for your business. However, in some cases, the line between an independent contractor and an employee can be surprisingly blurry.
This article highlights the key differences between these two types of workers to help you stay compliant and make informed decisions when bringing new talent on board.
Let’s dive in!
What Is an Independent Contractor?
An independent contractor is a self-employed individual who provides services to an entity. They run their own business; therefore, they are responsible for their taxes, insurance, and other business expenses.
Companies often hire independent contractors to perform specific tasks or projects. Since they are not considered employees, they are not on the company payroll and do not qualify for employee benefits. Typically, they are paid a flat fee or hourly rate for their services.
As their name suggests, independent contractors have complete autonomy over their work, setting their own pace and choosing their methods.
What Is a W-2 Employee?
A W-2 employee is a traditional employee who works for a company. They receive a W-2 tax form from their employer (hence, their name). This form reports the employee’s annual earnings, and the federal, state, and local taxes withheld from their paychecks.
Employees are eligible for employee benefits such as health insurance, retirement plans, and paid time off.
Finally, the employer has control over their work, including their hours, tasks, and working conditions.
The Key Differences Between an Independent Contractor and an Employee
When it comes to hiring new talent, companies can either hire independent contractors or W-2 employees. Let’s go over the key differences between each of these types of workers:
| Independent contractors | W-2 employees | |
| Taxes | Responsible for paying their own taxes, including income, Social Security, and Medicare taxes. | The employer withholds federal, state, and local taxes from the employee’s paycheck and pays a portion of Social Security and Medicare taxes. |
| Benefits | Not eligible for employer-sponsored benefits. | Typically, eligible for benefits like health insurance, retirement plans, and paid time off. |
| Schedule, autonomy | Greater autonomy. They determine when and how much they work. | The employer determines their schedule and work hours (full-time employees work at least 30 hours per week). |
| Salary | They are paid a flat rate or hourly rate, usually upon project completion. | They receive wages at legally compliant rates, or a salary. |
| Training and development | Responsible for their own training and career development. | The employer should provide onboarding, regular training, and offer career development opportunities. |
| Workload | Assignments are accepted on a case-by-case basis, and they can reject or opt out of assignments. | The workload is assigned by a supervisor, and workers are required to meet set criteria for performance. |
| Materials, tools, and equipment | They use their own materials, tools, and equipment. | It should be provided by the employer. |
| Exclusivity | They usually work for multiple clients. | They generally work for one employer. |
Hiring an Independent Contractor or an Employee: What’s Best?
It depends. Deciding whether to hire an independent contractor or an employee requires a careful examination of your company’s goals and specific needs.
When to Hire an Independent Contractor
Hiring an independent contractor might be a good choice for short-term, one-off projects, or tasks that have a clear beginning and end. It might also make sense if you are seeking specialized skills or expertise that’s not readily available within your company.
For projects that require flexibility, hiring contractors allows employers to scale their teams up or down based on project needs, avoiding long-term commitments. Finally, hiring an independent contractor can be a cost-effective approach to reduce the overhead costs associated with employee benefits, taxes, and administrative burdens.
When to Hire an Employee
Companies should hire employees for tasks or roles that require consistent, long-term effort.
By securing a pool of talent for the long term, you can promote collaboration among co-workers and create a strong company culture. This can ultimately drive growth and innovation in your business.
For certain roles, companies might prefer having more control and supervision over employees’ work, to ensure consistent quality and adherence to company standards.
What Are the Risks of Worker Misclassification?
Misclassifying workers, whether intentionally or not, can expose your business to serious legal and financial consequences.
These are the main risks that companies face when misclassifying workers:
- Tax violation fines. If you wrongfully classify a W-2 worker as an independent contractor, the IRS may assess back taxes, penalties, and interest on unpaid payroll taxes. State and local tax authorities may also impose penalties and interest. You can be charged your share of FICA that you should have paid, plus 40% of the FICA your worker should have paid.
- Federal law violations. Misclassified workers may be entitled to minimum wage, overtime pay, and other wage and hour protections under the FMLA (Fair Labor Standard Act). You can face lawsuits from your employees, costly fines of up to $1000 per worker, and even criminal charges.
- Unpaid workers’ compensation. Misclassified workers may not be covered by workers’ compensation insurance, leaving the company liable for workplace injuries.
Keep Your Business on the Safe Side with Access Point
Different business needs might require different types of workers. Being able to clearly differentiate between independent contractors and employees is key to avoiding misclassification risks.
Keeping up with complex (and constantly changing) labor and tax regulations can be overwhelming, especially if you lack the expertise and don’t have best practices in place to ensure compliance at every step of the way. If that’s your case, seeking legal and tax advice from a seasoned partner might be the best approach.
At Access Point, we provide comprehensive HR solutions to help small and medium-sized businesses navigate worker classification, employee relations, benefits, safety regulations, and more.
Need help keeping your business compliant? Contact us today to schedule a consultation and learn how our expert team can help protect your business.