One of the first milestones in a growing business occurs when the owner realizes that she cannot do it all herself.  Congratulations if it’s time to grow!

But take heed, owners: how you choose to grow can have a serious impact on your pocketbook.

Rather than wade into becoming an “employer,” with all the rights, responsibilities and regulations that entails, many businesses choose to outsource work to independent contractors.  While each group has its pros and cons, it is important that your new staff is properly categorized and compensated accordingly.  Mis-classifying an employee as an independent contractor can run afoul of the IRS, the Department of Labor, your state’s department of revenue, and various state and federal laws, each with its own array of financial penalties.

How do you know whether your new hire should be an independent contractor (who receives an IRS form 1099) or an employee (who receives a W-2)?  Not to sound too much like a lawyer, but it depends.

The IRS has an 11-factor test to determine how employees should be categorized.  Those eleven factors fall into 3 broad categories, according to the IRS’s guidance:

Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. 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 keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Frustratingly, there is no bright-line rule, which can create uncertainty for potential employers.  Merely having an “independent contractor agreement” will not necessarily be enough.  Some additional considerations include:

  • Do you want to control when, where and how the person performs his job? Are you expecting this person to have a set schedule and clock in at your offices?  Or will he have flexibility about the way he chooses to prioritize tasks and complete the assignment?
  • May the contractor take on other work/clients, or will she work only for you?
  • Will the person participate in any benefit programs (retirement, vacation)?
  • Is the relationship for a short duration, or on a project basis?
  • Who will provide liability insurance in case the contractor makes a mistake?

The more of the relationship you want to control as the owner, the more likely it is that you will want to hire an employee.  If, however, you merely want to outsource work, much as you would with your outsourced social media strategist, bookkeeper, CPA, attorney or other professional, then you may be more comfortable with an independent contractor relationship.

Still unsure?  It’s always best to consult with counsel if you are worried about the grey areas.