Employee or Independent Contractor?

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How does an employee differ from an independent contractor? This question is important if your business employs workers. Like most employers, you are probably required by state law to provide workers compensation benefits to employees injured on the job. However, you are not obligated to provide benefits to injured independent contractors.

Distinguishing employees from independent contractors isn't easy.

For one thing, there are no universal guidelines employers can use to make this distinction. Rules have been established by the Internal Revenue Service, by federal and state labor regulators, and by the courts. Unfortunately, these rules are not consistent. Thus, a worker deemed an independent contractor under one set of rules may qualify as an employee under another.

Meaning of Independent Contractor

The meaning of independent contractor varies from state to state. Some states have specific statutes that define the term. Others rely on case law (previous court decisions). Some states determine the status of a worker based on a list of criteria. To qualify as an independent contractor, a worker must meet some or all of the criteria. Some states designate certain workers, such as real estate agents, independent contractors based on their occupation.

While there is no national consensus as to what constitutes an independent contractor, many states apply common principles.

One of these has to do with independence. To qualify as an independent contractor a worker--not the employer--must have control over his or her work.

In many states, the process of determining whether a worker is an independent contractor or an employee begins with the following questions:

  • Does the employer control only the outcome of the work? Does the employer also control the means and method by which the work is performed? If the worker is an independent contractor, he or she sets the work schedule and decides what tools and procedures are used to get the job done. The employer controls the final product only.
  • Does the worker operate an independent business that is separate from the employer's business? An independent contractor has an established business distinct from the employer's business. He or she performs work for businesses other than the employer.  

These are only some of the factors states may consider to determine whether a worker qualifies as an independent contractor.

Note that a written agreement with a worker stating that he or she is an independent contractor will not guarantee that the worker will be considered a contractor by the state workers compensation board. States typically focus on the degree of control the employer exerts over the worker rather than the terms of a contract.

Misclassification

Many employers misclassify workers inadvertently. However, some employers intentionally misclassify employees as independent contractors as a ploy to save money on insurance premiums. This tactic is a bad idea! 

For one thing, failure to purchase mandated workers compensation coverage may be grounds for a lawsuit against the employer by an injured employee. Secondly, many state workers compensation laws prohibit employers from deliberately misclassifying employees as independent contractors.

Employers that violate these laws may be subject to fines, civil penalties, criminal charges and even prison.

Insurer Audits

Some states randomly audit employers to ensure that workers are properly classified. However, most states rely on insurers to conduct audits.

A majority of workers compensation policies are subject to an annual audit. The audit ensures that a premium has been charged for all workers entitled to workers compensation benefits. When purchasing a workers compensation policy, an employer pays a deposit premium based on estimated payrolls. The actual premium is determined after the policy has expired.

The final premium is based on actual payroll and classification codes. If the insurer determines that workers designated as independent contractors are really employees, it will assign a class code and payroll to those individuals.

The employer may ultimately be charged a large additional premium.

Subcontractors

Does your company hire subcontractors? If the answer is yes, you must ensure that all subcontractors have purchased workers compensation insurance. This is important for two reasons. First, an employee of an uninsured subcontractor who is injured on the job may seek recovery for his or her injury from you (the general contractor). You can protect yourself against such suits by insisting that all subcontractors provide a certificate of insurance verifying that they have purchased workers compensation insurance.

There is a second reason why it is important to obtain certificates of insurance from subcontractors. When your insurer audits your policy it will make sure that all subcontractors you've hired have provided a certificate. The auditor will charge you a premium for each uninsured subcontractor. The premium will be based on the subcontractor's payroll and the appropriate classification codes. If you cannot provide payrolls for those subcontractors, your insurer may base the premium on the cost of the subcontractor's work.