How to Classify Independent Contractors vs. Employees
How to Classify Independent Contractors vs. Employees

How to Classify Independent Contractors vs. Employees

It’s 2019, the gig economy is booming, and independent contractors are in high demand. Forbes suggests that by as early as next year, the gig economy will make up 50% of the U.S. workforce. With more businesses partnering with independent contractors, it’s essential that employers properly classify workers.

Here’s how to distinguish employees from independent contractors, and what happens if you don’t.

Employees vs. Independent Contractors

Aside from taxes, the biggest difference is the level of control an employer has over the worker.

Typically, an employer that partners with an independent contractor defines the scope of work but doesn’t have control over how the project is completed. Because the independent contractor often uses their own tools and equipment, expenses aren’t usually reimbursed.

Independent contractors are just that… independent. They’re either paid by the project or by the hour, they set their own schedules, they can work offsite, and unlike employees, their work usually isn’t key to the success of the business.

How the IRS Determines Classifications

The IRS considers three categories when classifying independent contractors:

  1. Behavioral Control
  2. Financial Control
  3. Type of Relationship

  Behavioral Control  Financial Control  Type of Relationship 
Employee  Has on-the-job training, set hours and guidelines for how their work should be completed.   The worker has guaranteed wages or salary.  Receives “employee type” benefits (i.e. PTO, insurance, pension plans, etc.) 
Independent Contractor  Sets their own hours and decides how the project should be completed. Paid a flat fee per project or job.  Contracted for a set time or number of projects. 



When determining the classification of an employee, keep this IRS quote in mind:

“There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another”.

The 2 Major Penalties for Misclassifying Employees

  1. Fines and Back Pay: If the Department of Labor (DOL) determines that misclassification was unintentional, an employer may be responsible for:
    • $50 for each unfiled W-2
    • 1.5% of the worker’s wages, with interest
    • 40% of the worker’s FICA contributions (Social Security and Medicare)
    • 100% of the employer’s FICA matching contributions
    However, if the DOL determines misclassification was intentional, an employer may be responsible for:
    • Maximum penalty of 1 year in prison
    • Up to $1,000 in criminal penalties for each misclassified employee
    • 20% of all employee wages paid
    • 100% of FICA contributions for both employer and employee
  2. Benefits: If a misclassified employee files a complaint with the DOL, they may be eligible for benefits owed, including:
    • Overtime
    • PTO
    • Health and welfare coverage
    • 401(k) contributions

Monetary fines aren’t the only challenge you’ll have to overcome. Fines and class action lawsuits can significantly tarnish your brand image, making it harder to recruit top talent, retain clients and grow. Together, these penalties can threaten the survival of any small to medium-sized business.

6 Basic Tips to Protect Your Business from Misclassifications

  1. Ensure there is a written contract in place for each independent contractor explaining their classification.
  2. State in the contract that independent contractors are not entitled to employee benefits.
  3. Provide all independent contractors with Form 1099 as required by the IRS.
  4. Document the factors you used to determine the worker’s classification.
  5. Obtain a worker’s full name, address and Social Security number before you pay them.
  6. Review your employee handbook and job descriptions to ensure workers’ duties are in line with what their role demands.
Keep in mind: the IRS will assist you in determining the classification of a worker: just file Form SS-8. Until the IRS makes a decision, you should treat the worker as an employee.

independent contractor vs employee

Can a Worker Be Both an Employee and an Independent Contractor?

Here’s a puzzle: what if you employ a full-time worker and they also do the occasional contracted work for your business on the side? Can you pay this worker as both a W-2 employee and as an independent contractor?

The safest bet would be to classify and pay this worker entirely as an employee for all the tasks they perform. However, if the employee has an established outside business, and the contracted work doesn’t pertain to this employee’s duties, then you may treat the employee as an independent contractor.

For example, if you have an employee who works as a bookkeeper but also has a side photography business, you may be able to hire them as an independent contractor while paying them as an employee for their normal duties.

How Paycor Can Help:

We’re proud to keep more than 30,000 organizations up-to-date and compliant with federal and state employment laws. Interested in learning more? Consult with a Paycor representative.

*This content is for informational and educational purposes only and is not intended to be taken as legal advice. For legal advice, consult with your professional legal or tax advisor.


payroll compliance guide

More to Discover

3 Reasons to Invest in a Learning Culture: Recruit, Retain, Engage

3 Reasons to Invest in a Learning Culture: Recruit, Retain, Engage

Learning is a win/win for employers and employees. Learning-driven organizations tend to be more efficient, create more customer value and market leadership, and report higher customer satisfaction. Employees of all ages, especially Millennials, see re-skilling and upskilling as critically important, and often it’s the deciding factor in their decisions to take a new job or stay at their current company.In Paycor’s Guide, “3 Reasons to Invest in a Learning Culture,” you’ll learn how to invest in and build a learning culture. You’ll also learn the “why behind the what,” and see firsthand how your company’s learning impacts your ability to recruit, retain and engage talented people.Download Paycor’s Guide for actionable tips and insights...

Case Study: Shelba Johnson Trucking

Case Study: Shelba Johnson Trucking

After experiencing numerous implementation challenges and unreliable customer support Shelba Johnson Trucking had enough and began searching for a reliable HR and payroll provider. Read the case study below to learn how Paycor’s HCM platform helped eliminate manual processes and offer supervisors more visibility into hours worked and time off requests.

Webinar: Industry Spotlight: Higher Education - People Management and Labor Metrics that every CFO and President should know - 1/22/19 @2pm ET

Webinar: Industry Spotlight: Higher Education - People Management and Labor Metrics that every CFO and President should know - 1/22/19 @2pm ET

Paycor reviewed proprietary data from nearly 4,000 customers to identify key metrics that uncover opportunities to lower your labor costs and increase the productivity of your people. This session will: • highlight key areas of your business operations (recruiting, labor costs, and turnover) and detail true operational costs. • Identify key metrics that can be tracked and benchmarked for improved performance. • provide a cumulative and holistic look at the financial impact to your organization. Dean Bishop, Paycor’s ABACC Relationship Manager, will analyze the critical labor and people management metrics that matter to you and your executive peers. Plus, he’ll provide some tips to start benchmarking and implementing these metrics.Paycor,...

Webinar: Are you Leveraging HR to its Full Potential? - Customers Only

Webinar: Are you Leveraging HR to its Full Potential? - Customers Only

This session will focus on the common points of pain for both the administrator and employee and demonstrate how Paycor HR helps to overcome those challenges. We will take a deep dive into the workflows, notifications, mobile, Reporting & Analytics and more. Speakers: Kelly Silverman + Kyle Baker