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

Taking the Guesswork out of Employee Pay - Part 1

Taking the Guesswork out of Employee Pay - Part 1

Deep Dive - External Equity and Market Pricing Feel more comfortable with how you determine employee pay at your company by learning how to align market pricing with your business strategy, understanding survey data and market pricing steps. Speakers: Christine Ippolito & Joanna Hall Christine Ippolito, SPHR, SHRM-SCP - Christine is the Founder and Principal of Compass Workforce Solutions, LLC, a consulting firm providing strategic human resource expertise to small businesses to reduce exposure and increase profitability. She has served clients in a leadership capacity for 25 years in multiple industries and environments within Fortune 250, venture capital and equity-backed companies, as well as privately held and family-owned...

Taking the Guesswork out of Employee Pay - Part 2

Taking the Guesswork out of Employee Pay - Part 2

Deep Dive - Creating Base Pay Structure to Achieve External and Internal Equity Take what you learned about market pricing in Part 1 to the next level in Part 2 of creating a base pay structure by learning the steps and considerations in building a base pay structure. You will learn the different approaches that may be used to build a base pay structure and how to maintain your base pay structure and evaluate for effectiveness. Speaker: Christine Ippolitto Christine Ippolito, SPHR, SHRM-SCP - Christine is the Founder and Principal of Compass Workforce Solutions, LLC, a consulting firm providing strategic human resource expertise to small businesses to reduce exposure and increase profitability. She has served clients in a leadership...

Understanding FMLA Regulations

Understanding FMLA Regulations

What is the Family Medical Leave Act (FMLA?) The Family and Medical Leave Act (FMLA) is a federal law that allows eligible employees to take up to 12 weeks of unpaid leave in any given 12-month period for certain medical and family reasons without fear of losing their job. Signed into law in 1993, the FMLA is designed to help employees balance their work and family responsibilities while promoting equal employment opportunity for men and women. Who is Eligible for FMLA? An employee is eligible for FMLA leave if he or she has worked for a covered employer at least 12 months, completed at least 1,250 hours of work during the past 12 months and worked at a location within 75 miles of where the company employs 50 or more people. Keep in...

The Turnover Crisis in Restaurants

The Turnover Crisis in Restaurants

An Action Plan for Owners and Operators Restaurants across the country are experiencing high volumes of turnover at an alarming rate. In 2016, turnover exceeded 70% for the second consecutive year, and the turnover rate in the fast-food industry reached 150%, the highest since data was first captured in 1995*. With record numbers of restaurants and more jobs to choose from, employees are willing to take risks to find the right fit. The demand for restaurant workers isn’t going away, so it’s critical to find the right HCM provider who can help solve your HR challenges with the right combination of technology and expertise. More than 3,000 restaurants across the country depend on Paycor to help onboard new hires, pay them accurately and...