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Contractor? Employee? How to Avoid Misclassifying Workers

June 5, 2015
Small Business
Contractor or Employee? How to Avoid Misclassifying Workers
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When your small business takes off, you might need help. But you’re not quite ready to hire an employee, so you turn to freelancers. Or maybe having independent contractors makes the most financial sense for your business.

Whatever the reason, more small businesses are turning to contract workers. In fact, a study by Intuit predicts that a workforce of freelancers, temp workers and contractors will make up 40% of the U.S. labor market by 2020.

But there are legal issues to consider when hiring contractors. Take the ride-hailing services Uber and Lyft, which are facing lawsuits claiming their drivers — classified as independent contractors — are essentially employees.

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“Perhaps the hottest issue today is misclassifying workers,” says Michael E. Fiffik, a LegalShield attorney with Welch, Gold, Siegel & Fiffik, a law firm based in Pittsburgh. “That’s because employers have an incentive to treat workers as independent contractors rather than employees.”

NerdWallet asked labor attorneys about issues to keep in mind when hiring contract workers.

Jim Chester

The difference between a contractor and an employee isn’t always obvious, says Jim Chester.

Know the difference

Jim Chester, a managing partner with Dallas-based law firm Chester Jeter Siekierski LLP, says the difference between a contractor and an employee is not always obvious. In some cases, small businesses hire contractors and employees to do similar work — say, a big project that requires temporary workers.

Generally, independent contractors have their own tools or materials, have multiple clients and take little or no instruction from you on when and how the work gets done. As an employer, you also don’t cover payroll taxes, workers compensation insurance or other types of workplace benefits for contractors. As Dallas attorney Kevin Vela puts it, “Employees are significantly more expensive.”

In addition, employees have more legal protections, Chester says. For instance, employees are covered by federal anti-discrimination laws, whereas contractors are not, according to the U.S. Equal Employment Opportunity Commission.

Don’t rely on an agreement

Just because you — or the worker — say he or she is an independent contractor does not automatically make it so, Fiffik says. “In some states, there’s a presumption that a worker is an employee,” he says.

Although it’s helpful to have a written agreement between you and a contractor, it’s important to note that it’s not binding on any government regulator, he says.

Michael E. Fiffik

“Perhaps the hottest issue today is misclassifying workers,” says Michael E. Fiffik.

Seek advice

You can face costly consequences if you misclassify workers as contractors. You may have to pay back wages and penalties, even if the misclassification was unintentional, Fiffik says.

The U.S. Department of Labor provides guidance on employee-contractor classification, as does the IRS. Your state’s labor office can also provide guidelines. The Texas Workforce Commission, for instance, has an independent contractor test that can serve as a useful tool, Vela says. If the issue gets too tricky, consider consulting an attorney to avoid any misunderstandings and potential legal and financial troubles.

For more information about how to start and run a business, visit NerdWallet’s Small Business Guide. For free, personalized answers to questions about starting and financing your business, visit the Small Business section of NerdWallet’s Ask an Advisor page.

Hanah Cho is a staff writer at NerdWallet, a personal finance website. Email: [email protected]. Twitter: @hanahcho.

Top photo via iStock.