Worker Classification: Employee vs Independent Contractor
Worker classification is being discussed a good deal among solopreneurs to large corporations these days. It’s a pressing issue, especially as more businesses are engaging freelancers, contractors, and other independent professionals to get specialized work done and remain competitive.
With this rise in usage comes greater risk of worker misclassification, because the rules around classification are not easy to interpret and are frequently changing. Get classification wrong and you could be responsible for serious tax consequences and employment law violations.
However, you can still protect yourself. Once you understand these fundamentals of worker classification, you can safely continue contracting independent professionals to help grow your business:
- What is worker classification compliance?
- Why it matters how a worker is classified
- What are the two classifications of workers?
- How to determine worker classification status
- Keys to determining the difference between employee and IC
- How to protect your business from misclassification risk
- Ways to get help with classification
What is worker classification compliance?
Worker classification compliance is determining whether the person you engaged to provide services is classified as an employee or independent contractor (IC).
The tricky part is, a worker’s classification status can change depending on how they’re expected to perform the work. Which means a person can be a freelancer receiving 1099 forms from clients showing they earned income outside of a traditional job, but all that still doesn’t guarantee they’re classified as an independent contractor.
Why it matters how a worker is classified
As an employer, worker classification matters because it determines what taxes and benefits you’re responsible to pay for each person you work with. If you misclassify a worker as an IC when they should be an employee, you could end up responsible for unpaid taxes, wage and hour violations, benefit claims, and much more.
If you’re an independent contractor, classification matters because it determines what taxes you pay and what benefits you’re eligible to receive. For example, independent contractors pay a self-employment tax and are not eligible for unemployment benefits and overtime pay.
What are the two classifications of workers?
The two main worker classifications are employee and independent contractor. In general, here’s how the Internal Revenue Service (IRS) defines each worker classification:
- Employee: A person is an employee if they perform services for you and you can control what work will be done and how it will be done. Control includes requiring them to work onsite or during specific hours, or providing them with training.
- Independent contractor: A person is an independent contractor if they perform services for you and maintain complete control over what will be done and when and how it will be done. You, the person paying, have some say over the deliverables or outcome of the work but not much else.
For example, a dentist is usually a self-employed professional and an independent contractor. You can pay them to pull a tooth (the result), but you can’t tell them what tools to use or how to pull it.
How to determine worker classification status
Unfortunately, determining worker classification isn’t a black and white test. It’s more of a balancing act of several factors. The primary factor to watch out for is control. The more control you have over a person’s work, the more their status may lean toward employee.
To avoid misclassification risk, be sure to classify a person for every engagement. You may want to keep these guidelines in mind when deciding a worker’s classification:
Behavioral control: Do you have the right to direct the work performed by the worker? Even if you don’t put those rights to use, do you have them? For example:
- Can you tell them when they must work, where to work, what tools or supplies they must use, or train them on how to do the work? If so, that may indicate employee status.
- How much instruction can you give them? More detailed instruction signals you have more control.
- Do you have a system in place that monitors or evaluates their work? This could be monitoring the number of calls a customer service agent handles per hour, for instance. Having an evaluation or monitoring system leans towards having control.
Financial control: Do you have a right to direct the financial and business aspects of the person’s job? For example, you may be exercising financial control if:
- You reimburse them for work-related expenses.
- You made a sizable investment in the equipment the worker uses.
- The worker doesn’t have an opportunity for profit or loss.
- The worker doesn’t publicly seek other business opportunities.
- The worker is generally guaranteed a regular amount of pay for an hourly, weekly, or other period of time. Independent contractors are often paid on a project or deliverable basis.
Relationship control: The type of relationship depends upon how the worker and business perceive their interaction with one another. This includes:
- Written contract: Contracts describing the relationship between the worker and business are vital. The details of how you describe the working relationship help determine their status.
- Permanency: Is there an expectation that the relationship will continue indefinitely? If there’s no end date (e.g., by project or specified period), then it may show relationship control.
- Benefits provided: Employee-type benefits like insurance and vacation pay signal relationship control.
- Services provided: If the work performed is seen as a key aspect of the regular performance of the business, then it suggests control.
Keys to determining the difference between employee and IC
An easy way to remember the difference between employees and independent contractors is that ICs operate like a business just as many dentists, lawyers, accountants, and other professionals do.
When working with ICs, you explain what you need done and rely on them to deliver it. Using the dentist example from earlier, you tell them you’ve got an aching tooth and let them decide how to resolve it.
Just remember that independent contractors work independently. They often:
- Publicly market their services to other businesses.
- Pay for all the major equipment and supplies needed to perform the work.
- Set and negotiate their own rates.
- Do not require extensive training.
- Are free to delegate or subcontract the work to someone else.
- Work for a limited time (e.g., by project or specific period).
- Do specialized work that’s not part of your primary business.
10 questions to ask when deciding if a worker may be classified as an independent contractor or employee
Note that a yes or no to a single question may not alone determine classification status.
How to protect your business from misclassification risk
The first step to protecting your business from misclassification risk: Make sure the professional works independently (e.g., they pay for their own tools, negotiate their own rates). The second step: Be sure to treat ICs like an independently operating business. Just as you wouldn’t tell a business how to do their job, remember that an IC calls the shots regarding many of the terms of their engagement.
Actions to avoid
While working with any independent contractor, you can unintentionally move the worker from IC to employee status. If a worker feels they’re not classified properly, that can lead to serious issues. So, be careful to avoid the following as much as possible when working with independent contractors:
- Require work not specified in an agreed contract
- Set the work location or work hours
- Provide major tools or equipment
- Train on skills needed to do the work
- Specify process steps or work methods
- Give detailed instruction on how to do the work
- Schedule regular or frequent meetings or check-ins
- Prohibit them from delegating tasks to subcontractors or employees
- Preclude working for other clients
What you can specify is the work you need done and any deadlines. For example, you need a mobile app built for ___ platform that includes ___ features, and it must be delivered by ___ date.
The brief video below explains how to work with ICs.
Ways to get help with classification
Whenever the correct classification of a worker is unclear, it’s wise to consult an expert. Upwork provides three ways for you to get the worker classification help you need, at any scale.
Contract an independent professional
Engage an employment law attorney or other legal professional familiar with independent contractor issues for a consultation or to handle classification for you. Clients rate the legal specialists on Upwork 4.9 out of 5 on average, so you’re in the right place to help you find someone great.
Work with Upwork Compliance Service
If you want Upwork to determine the appropriate classification of the workers you engage through the platform, consider using Upwork Compliance Services, which are available to Upwork Enterprise clients who subscribe. Clients find Upwork Compliance Services appealing because they take the burden off of their own internal resources and can expedite time to engagement.
Upwork provides you with worry-free classification services in the following ways:
- Our team of compliance experts, backed by our legal team, will determine the correct classification for each worker, for each engagement.
- Upwork offers indemnification from misclassification risk to Compliance clients.
- Upwork’s trusted, third-party staffing agency will act as employer of record (EOR) for workers classified as employees.
- The key documentation will be stored in the platform, so you can readily access it.
Use Upwork Payroll
If you determine that a worker is appropriately classified as an employee because you need more control over how the person works (e.g., working at a specific time or place, or requiring training), we offer Upwork Payroll.
You can engage independent talent through Upwork Payroll, and while you work with the person as needed, they will be employed by Upwork’s trusted, third-party staffing agency. The staffing agency handles the administrative and legal details, such as wage payment, employment taxes and benefits compliance.
Classification may seem daunting, but if you’re conscious about the level of control you’re exerting over the work and know what actions to avoid, you can reduce your chances of misclassifying a worker. And when you need help with classification, Upwork provides options to ensure you’re protected, at any scale.
Nothing in this article constitutes or is to be relied upon as legal advice. Relevant considerations and laws for classifying workers vary depending on the particular situation. Clients are encouraged to seek advice from their own legal advisors.