Startups: Employees or Independent Contractors?

Good news… your business or organization has more work than you can handle on your own! Now it’s time to hire some help. But before you dive in, there are important issues to consider in terms of the laws that will apply to employees vs independent contractors.

Why does it matter if workers are classified as employees vs. independent contractors?

Simply put, unlike independent contractors, federal and state employment laws tightly regulate what you must do for employees. If you hire an employee, you must, for example:

  • Comply with wage and hour laws for minimum wage, overtime, breaks, etc.,
  • Withhold federal and state taxes,
  • Confirm employee eligibility to work in the United States,
  • Report newly hired employees,
  • Obtain worker’s compensation insurance,
  • Post required employee notices, and
  • File quarterly taxes.

Often times, new businesses and organizations simply don’t have the capital to comply with all of these laws or are not ready to set up the infrastructure necessary to comply with employment laws. A common solution is to hire an independent contractor instead of an employee.

img_01

How do you determine if workers are employees vs independent contractors? 

Correctly classifying someone as an independent contractor, as opposed to an employee, is very important. An employer in California must comply with both California employment laws and the federal Fair Labor Standards Act (FLSA) for its employees. But a business that hires an independent contractor is not bound by many of these laws. California and the federal government have separate but similar tests for whether a worker will be considered an employee or an independent contractor. It is important to note that a court or agency scrutinizing a relationship between a worker and a business or organization will not simply accept the classification put forth by the business or organization. In other words, just because the relationship is based on an “Independent Contractor Agreement” does not mean that a court would accept that classification. In California, the federal government and the California Labor and Workforce Development Agency have entered into an agreement to coordinate enforcement of employment laws where misclassifications occur.

Another reason why correct classification is very important is because under both the California and federal tests, an officer of a corporation could be held personally liable for noncompliance with employment laws despite the fact that the individual would generally enjoy limited liability through the corporate form. This is because an individual or an entity may be deemed an “employer” under these tests.

Under the federal test, the main consideration in determining whether an employment relationship is present is the amount of control and supervision over the person doing the work – the more control, the more likely that an employment relationship exists. A person or entity may be deemed an “employer” depending on: (1) the ability to hire and fire workers, (2) the level of supervision and control over work schedules or conditions of employment, (3) whether the worker is paid at fixed rates and how the worker is paid, and (4) the level of maintenance of employment records. In looking at whether a worker is an employee or an independent contractor, the following factors are considered (with an overall eye towards the level of control and supervision of the work):

  • The working person’s investment in facilities and operations;
  • The working person’s opportunity for profit and loss;
  • The degree of independent initiative, judgment, or foresight exercised;
  • Whether the person maintains an independent business or organization;
  • The length of the relationship; and
  • The extent to which the person’s services are integral to the business.

California uses a multi-factor “economic realities” test, which also focuses on the level of control over the worker. The factors examined in California may include:

  • Whether the person performing services is engaged in an occupation or business distinct from that of the principal;
  • Whether or not the work is a part of the regular business of the principal or alleged employer;
  • Whether the principal or the worker supplies the instrumentalities, tools, and the place for the person doing the work;
  • The alleged employee’s investment in the equipment or materials required by his or her task or his or her employment of helpers;
  • Whether the service rendered requires a special skill;
  • The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;
  • The alleged employee’s opportunity for profit or loss depending on his or her managerial skill;
  • The length of time for which the services are to be performed;
  • The degree of permanence of the working relationship;
  • The method of payment, whether by time or by the job; and
  • Whether or not the parties believe they are creating an employer-employee relationship may have some bearing on the question, but is not determinative since this is a question of law based on objective tests.

The employee vs. independent contractor inquiry is done on a case-by-case basis. Businesses and organizations taking on workers should exercise caution in approaching these relationships. A good rule of thumb is that a business or organization can dictate the final product of an independent contractor but should not direct the means by which the product is produced. Of particular importance are the contractor’s ability to set his or her own schedule, project-based instead of hourly payment, and the use of the contractor’s own equipment, knowledge, and training in performing the task.

(See IRS Publication 15-A for a further discussion and industry-specific examples of the distinction between independent contractors and employees.)

First published on Elevate Law and Strategy‘s blog: “What is the Difference Between Employees vs Independent Contractors?” by

Connect with Elevate Law and Strategy: Facebook | Twitter | Email: info@legalelevation.com

DISCLAIMER: The information in this article is provided for informational purposes only and should not be construed or relied upon as legal advice.

Leave a comment

Your email address will not be published.