Independent contractor vs. part-time employee checklist for small businesses

11 MIN READEditorial Policy

Are you trying to understand the difference between an employee (whether full-time or part-time) and an independent contractor?

More small businesses are getting caught up in the tangle of information available on whether or not they can classify a worker as an independent contractor or whether the person is legally an employee.

It’s not always clear.

California state regulators warn on their website that “it is possible that the same individual may be considered an employee for purposes of one law and an independent contractor under another law.” Federal regulators say the same thing.

So both state and federal regulators caution business owners that, before establishing a working relationship, they “thoroughly” research and analyze it. A wrong decision could mean fines and penalties for your business.

We can help you learn how to choose the correct category for your worker.

Just remember, the bottom line is that independent contractors are self-employed individuals, so your business has to have a distinctly different relationship with them than it does with its employees.

The two big questions for contractors vs. employees

1. Do you have the right to control how the person does the work for your business? If yes, they’re an employee

If you do, or even if you just have the right to exercise control, then your worker will be considered an employee by regulators.

For example, if you do the following:

  • Set the worker’s hours

  • Decide where the person will work

  • Provide the equipment or tools to do the work

  • Dictate what work will be done, and when it will be done

While there is no single factor that you can use to decide if a worker is an employee or an independent contractor, the degree to which you have the right to control what work is done and how it is performed is one of the most significant, according to California regulators.

For example, if you own a restaurant and hope to classify your bartenders as independent contractors, think twice if you also plan to set their working hours, provide their equipment and require them to work onsite and attend staff meetings. Your ability to control those factors means the workers are considered employees by regulators.

2. What type of financial and business relationship do you have with your worker?

This can be a tough question to answer! The 6 questions below will help you define this a little more clearly. Again, this is not the only test but it’s important to understand because these factors are what courts have used to interpret federal and state labor laws.

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6 checklist questions about the financial and business relationship with the employer

Here are six questions to ask when trying to figure out if you have a legal employer-employee relationship with your worker, according to federal regulators and the Internal Revenue Service:

1. Do you pay the worker an hourly wage?

Yes:  Employee. An employee is typically paid a guaranteed wage per hour or a salary. That arrangement indicates an employer-employee relationship even if the worker also earns a commission, according to the IRS.

No:  Independent contractor. To create an independent contractor relationship, you should pay a flat fee after a certain job or task is done, according to the Society for Human Resource Management.

2. Do you pay the worker’s expenses?

Yes: Employee. As an employer, you reimburse an employee for work-related expenses that person incurs to get the job done. The employee is not responsible for covering these expenses for your business.

No: Independent contractor. As an independent business owner, an independent contractor pays his or her own expenses. The IRS especially looks at fixed ongoing costs the contractor has whether or not the person is currently performing work as a strong sign of independent contractor status.  If there are costs associated with the work being done for you, an independent contractor typically includes the costs in the contracted fee.

3. Do you have the right to fire the worker?

Yes: Employee. You can fire an employee for no reason as long as you don’t do it to discriminate against the person or to retaliate for, say, reporting a safety violation.  If the person has an employment contract with you, you can’t fire them without cause unless the contract says so. Still, that person is an employee.

No: Independent contractor. You can’t fire an independent contractor. That person is self-employed. You should both sign a written contract before any work starts. Then, if either party violates the terms, the other person can terminate the business relationship without facing a possible penalty, such as a breach of contract action.

4. Is your business relationship with the worker ongoing?

Yes: Employee. When you hire a worker with the expectation that the business relationship will go on for an indefinite period of time, the IRS sees that as an intent to create an employer-employee relationship.

No: Independent contractor. An independent contractor, on the other hand, is hired or contracted for a specific project or period.

5. Does the worker do routine tasks for your business or the same work your business does for its customers?

Yes: Employee. For example, your dental practice wants to add a part-time dental hygienist to help with your patient workload. Since the hygienist will be doing work that is integral to your business, that worker will have to be hired as an employee.

No: Independent Contractor. If the person works in a different business than yours or has a specialized skill, for example the worker is a web designer you hire for a website project at your landscape architecture firm, then the person can be classified as an independent contractor.

6. Could the worker lose money from doing the work?

Yes: Independent contractor. As an independent business owner, an independent contractor faces the possibility of losing money. For example, business expenses could be greater than the income from the work. There is also the potential to earn a higher profit for the contractor’s business if the job is managed more efficiently, or to add new clients to offset the expenses.

No: Employee. An employee’s business expenses are covered by the employer. The employee doesn’t face a financial loss because expenses the worker incurred for your business exceed the worker’s wage or salary.

Lastly, it’s important to know that your small business can’t rely on paperwork alone to create an employee or independent contractor relationship.

For example, signing a contract with a worker doesn’t make that person an independent contractor.

Nor does giving the worker at tax time an IRS “Form 1099-MISC, Miscellaneous Income,”  which is used for independent contractors, instead of the “Form W2, Wage and Tax Statement” given to employees.

So take a careful look at the factors we’ve outlined when deciding if your worker is legally an employee or an independent contractor. And seek advice from a respected employment-law expert if you are still unsure about how to classify your workers.

It’s understandable why your small business might prefer to hire a worker as an independent contractor instead of an employee. You can avoid minimum wage and overtime rules, payroll taxes, unemployment insurance premiums and in some states, disability insurance premiums. And you don’t have to reimburse a contractor for business expenses or cover benefits like health insurance.

In fact, relying on independent contractors is how many newer service businesses in the so-called gig economy survive. But that growing trend has drawn increased scrutiny from regulators and plaintiff attorneys, including ongoing lawsuits.

So now, more than ever, it’s important that your small business know the difference between an independent contractor and an employee. Make the right choice when it comes to adding workers.

Start a 401(k) with Human Interest

A Human Interest 401(k) plan can connect directly with your favorite payroll provider and has zero transaction fees.

Related article: 401(k) Benefits for Interns and Part-time Employees

Cyndia Zwahlen, a former small-business columnist for the Los Angeles Times, is a freelance business writer and editor for media, academic and business clients. She founded the Small Biz Mix blog.

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