Independent Contractor? Not so Fast!

Your small business is booming. You need to hire help. But should your new hire be an employee or an independent contractor?

Or… you’re self-employed, providing services to ride-hailing companies like Uber or Lyft. Are you an employee, covered by labor laws and your costs reimbursed—or should you be considered an independent contractor?

As more Americans earn their living from the “gig economy,” the seemingly boring topic of “employee status” is heating up, with far-reaching consequences for companies like Uber, Lyft, Airbnb, and Task Rabbit. But it’s also certain to have implications for your small business in the next few years.

Consider some of the recent activity related to employee status:

In June, the California Department of Labor determined that an Uber driver was an employee, not independent contractor.
In May, Florida decreed that an Uber driver was an employee, entitled to unemployment insurance.
In June, FedEx established a $228 million fund to pay claims by FedEx Ground workers who were determined to be employees, not independent contractors, by the Ninth Circuit Court of Appeals.
Lawsuits against Uber and Lyft have been approved to proceed to jury trials in federal courts.
In July, an employee for an “on-demand” cleaning service, Handy, filed suit saying she should have been treated as an employee, entitled to minimum wage protection.

But these issues don’t just affect huge corporations. Many small businesses prefer to classify workers as independent contractors so they don’t have to pay payroll taxes, provide benefits, be subject to labor laws such as overtime pay. Some workers, too, want to be classified as independent contractors so they don’t have payroll taxes deducted from each check (though they are still responsible for them), many of their business expenses are tax deductible, and they may have more flexibility in their working conditions.

Employment laws, however, restrict those choices even if both you and the worker agree. If you misclassify someone as an independent contractor when they should have been treated as an employee, the IRS will hit you hard with penalties and back taxes.

So let’s try to clear up a bit of confusion—although clarity is definitely hard to find in the murky waters of defining employee status.

The primary issue the IRS uses to determine employee status is who “controls” the worker. They look at three main areas:

Behavioral: Does the worker control how they do the work? Who determines when and where the employee works, who controls the order or sequence of work processes?
Type of relationship: Is the work performed a critical and regular part of the business? How permanent is the relationship?
Financial: Does the worker have a significant investment—i.e., do they own their own tools?

Do they make their services available to other and/or work for other businesses?

In the decisions so far that have determined that workers should be considered ‘employees’ rather than independent contractors, the issues seemed to come down to the fact that the work was absolutely essential to the business and control. In Uber’s case, for example, there would be no business without the services of the drivers. And FedEx required drivers to pay for FedEx Ground branded trucks and uniforms; Uber decrees how many passengers a driver can take at one time.

These issues are certain to need clarification in the next few years. For now as you’re trying to decide whether to hire an employee or engage an independent contractor in your small business, keep these points in mind for determining the proper classification: