Independent Contractors or Employees: Why It Is so Important to Use the Proper Classification for the People that Work for You

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September 29, 2016

independent-contractorOver the past few years, there has been a concerted effort on the part of the US Department of Labor, as well as various state attorneys general, to target businesses that misclassify workers as independent contractors when those workers should be treated as employees.

As previously discussed on this site, there can be certain advantages to retaining the services of independent contractors rather than employees.  Utilizing such workers can, under some circumstances, help to reduce payroll expenditures and limit potential employment-related lawsuits and liability.  However, given the attractiveness of independent contractor classification, courts, regulatory agencies and state and federal tax authorities alike have increasingly ruled against attempts by businesses to label workers independent contractors when, in all material respects, those workers instead fit the definition of employees.

In light of ever-increasing regulatory scrutiny, businesses should seek knowledgeable counsel when deciding whether to designate workers as 1099-eligible independent contractors or W-2 employees.

When Should a Worker Be Classified as an Independent Contractor?

Independent Contractors: Workers with(out) Benefits

When a business is able to properly classify workers as independent contractors, rather than employees, that business may be able to reap certain tax-related benefits and limit potential liability.  For instance, a business that hires an independent contractor rather than an employee may not be required to pay social security or Medicare taxes, state unemployment insurance or workers compensation insurance or include that worker in the business’s otherwise standard benefits packages.

Further, businesses may be able to push business-related expenses to independent contractors that they would otherwise need to cover where the workers in question are employees.

In addition to those financial benefits, businesses may also be able to limit exposure to potential lawsuits that employees (but not independent contractors) would otherwise be entitled to bring – including suits based on discrimination, wrongful termination, overtime pay and other similar causes of action.

How Do you Determine when a Worker is an Employee as Opposed to an Independent Contractor?

Determining whether or not a worker is an independent contractor, as opposed to an employee, requires a fact-intensive, case-by-case analysis, which is based largely on a list of classification criteria provided by state and federal regulatory bodies.  Some of the key criteria include: (a) whether or not the business has control (or the right to control) the worker’s work-related activities and how the worker provides his or her services; (b) how compensation is determined, whether expenses are reimbursed and which party provides the necessary equipment; (c) whether or not employee-type benefits are provided; and (d) whether or not the working relationship is open-ended, or for a limited time/scope.

As mentioned above, state and federal agencies are increasingly reluctant to find that workers are independent contractors rather than employees, and for compelling reasons.  When businesses are permitted to hire independent contractors rather than employees, such classification, among other things, reduces the amount of state and federal taxes collected.  Given the interests of the state and federal government in such matters, it is not uncommon for state and federal agencies to audit businesses that hire independent contractors to confirm compliance with laws governing the classification of workers.  Businesses that are found to have violated those laws could face significant penalties, as well as the obligation to pay back wages and taxes for the wrongly-classified workers.

Given the foregoing, it is highly recommended that businesses retain competent legal counsel to ensure that workers are properly classified.

If you are interested in learning more about this topic, or require counsel in connection with potential hiring decisions, or current worker classification-related matters, please e-mail us at, or call us at (212) 246-0900.

The material contained herein is provided for informational purposes only and is not legal advice, nor is it a substitute for obtaining legal advice from an attorney.  Each situation is unique, and you should not act or rely on any information contained herein without seeking the advice of an experienced attorney.

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