Table of Contents
- What are the risks of worker misclassification?
- What is an employee?
- What is an independent contractor?
- What are the differences between employees and independent contractors?
- What factors distinguish an employee from an independent contractor?
- Independent Contractor Tests by State
- When should I hire an independent contractor versus an employee?
- If hiring an employee, use an Employment Contract
- If hiring an independent contractor, use an Independent Contractor Agreement
- How do I terminate work agreements with independent contractors versus employees?
- If firing an employee, use an Employment Termination Letter
- If firing a freelancer, use a Termination Agreement
- Avoid misclassification. Get it in writing.
What are the risks of worker misclassification?
What is an employee?
- Work for one company
- Are given training by their employer
- Have a set work schedule
- Work at the direction of their employer
- Do not have to provide tools or a workspace
- Are provided with company benefits
- Labor laws: Employees are provided with certain rights, like minimum wage, under the Fair Labor Standards Act. They are also protected under state labor laws.
- Tax regulations: Employers are responsible for deducting taxes from an employee's paycheck. They will then provide the employee with a W-2 form on a yearly basis.
What is an independent contractor?
- Work for multiple companies or clients
- Are not trained on a company’s policies and procedures
- Set their own work schedule
- Work on their own, based on a general request from the client
- Provide their own equipment and workspace
- Can register for benefits as self-employed
- Labor laws: Independent contractors are not considered employees under the Fair Labor Standards Act. This means they are not covered by the wage and work-hour regulations set forth in this act.
- Tax regulations: Clients do not deduct taxes from a freelancer’s payment. Instead, the independent contractor is responsible for ensuring the proper tax amount is paid. Usually, a client provides the contractor with a Form 1099 if they have paid the contractor $600 or more during the tax year.
What are the differences between employees and independent contractors?
Employee | Independent Contractor | |
Hiring documents | When hired, the employer provides the employee with an Employment Contract. | When contracted for services, an independent contractor and client enter into an Independent Contractor Agreement or a Service Agreement. |
Regulations | Federal labor laws protect employees, specifically the Fair Labor Standards Act, in addition to any state-specific regulations. | Independent contractors are not covered by the Fair Labor Standards Act. Independent contractor status is determined through a series of federal and state-specific tests, such as the ABC, common law, or economic reality tests. |
Taxation & tax forms | Employers deduct taxes. At the end of the year, the employer provides the employee with a Form W-2. | Clients typically do not deduct taxes. Clients must provide the contractor with a Form 1099 for any payments of $600 or more. |
Benefits | Employees are usually a part of the corporation's benefits programs, such as health insurance or stock options. | Contractors are not eligible for client benefit programs. They are responsible for independently enrolling in health insurance and other programs. |
Employment flexibility | Employees are governed by the policies and regulations laid out in the company's Employee Handbook. | Independent contractors set their own employment terms, including working hours, time off, and payment rates. |
Payment | Employees earn a salary and get paid according to the company's payment structure (weekly, bi-weekly, monthly, etc.). | It is up to the client and the contractors to decide how they will handle payment. Usually, the contractor sets their rates. |
Termination documents | For employees, use an Employment Termination Letter. | For independent contractors, use a Termination Agreement. |
Can an employee also be an independent contractor?
What factors distinguish an employee from an independent contractor?
Economic Reality Test
- Opportunity for profit or loss depending on managerial skill
- Investments by the worker and the employer
- Permanence of the work relationship
- Nature and degree of control
- Whether the work performed is integral to the employer’s business
- Skill and initiative
ABC Test
- A: The worker can complete work free from the employer’s control or direction.
- B: The work is outside the usual course of the client’s business or the work primarily occurs off the site of the business.
- C: The worker is engaged in an independent trade, occupation, profession, or business.
Common Law Test
- Behavioral facts, which show whether a company has the right to control how a worker does their job
- Financial control, otherwise known as if there are economic aspects of a job that an employer controls
- The type of relationship the worker and business have with each other
Independent Contractor Tests by State
When should I hire an independent contractor versus an employee?
If hiring an employee, use an Employment Contract
- The type and rate of compensation
- The frequency of payment
- Vacation time
- Specified work hours and work location
- Employee responsibilities
- Length of a probationary period
- Confidentiality, non-solicitation, or non-competition clauses
- Termination terms
If hiring an independent contractor, use an Independent Contractor Agreement
- Details about the type of service the contractor will provide
- Both the contractor’s and the client’s details
- Duration of the services
- Payment details, including how the contractor gets paid and the frequency of payment
- Retainer details
- Termination terms
- Confidentiality and intellectual property clauses
How do I terminate work agreements with independent contractors versus employees?
If firing an employee, use an Employment Termination Letter
- A description of the event(s) that led to the employee dismissal
- Any expenses owed to the employee
- The employee’s termination date
- Any details about severance pay or vacation payout (if applicable)
If firing a freelancer, use a Termination Agreement
- Details about the original contract
- The termination date of the contract
- Any final compensation details, if necessary