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  • Writer's pictureLNJ Employer Services

Independent Contractor Vs. Employees - The Differences and Why it Matters.


The idea of using an Independent Contractor can be extremely enticing. Less payroll taxes, less benefits expense, no workman’s compensation needed, no minimum wage or overtime rules to follow, call them in as needed…. Sounds dreamy, doesn’t it? Depending on the situation, an Independent Contractor (IC) can be very beneficial, when utilized properly. Just take care you are not misclassifying someone as an IC when they really should be on normal payroll as an employee. Read on to learn the true impact of misclassification.


Misclassification as an IC hurts the worker by not awarding basic protections under the Fair Labor Standards Act, which only covers employees. They are not subject to minimum wage or overtime, the added benefits like insurance and disability, or workman’s compensation if they are hurt on the job. Also, IC's have to carry their own General Liability Insurance. It would be a great time to do an internal audit and make sure you have current Certificates of Insurance (COI's) on file for each. When it comes to audit time, YOU will get penalized for your IC not carrying it!


But how important are taxes... really? The government just wants all of my money!

Payroll tends to be one of the largest expenses for a company, and the taxes don’t help. “Saving money” with misclassification is damaging to the economy as a whole. One example is the Old Age and Survivors and Disability Insurance (OASDI), aka Social Security. The 2022 OASDI Trustees Report states these tax dollars went to approximately 65 million people: 50 million retired workers and their dependents, 6 million widows of workers, and 9 million disabled workers. The total cost of benefits was $1,145 billion dollars. For many, OASDI is their only monthly income.


What is the government doing, and how is my business effected? To help combat the severe ramifications of misclassification, the IRS and Department of Labor published a Memorandum of Understanding outlining their cooperation. Since that time, they have discovered this is rampant across all industries. A Tennessee home health care services provider was discovered to have misclassified over 50 workers, resulting in recovering back wages of over $350,000.


How do I determine which is correct for my situation? In 1987, the IRS created a IRS 20 Factor Test to help determine IC versus Employee. There have been some minor updates, but not much. In December of 2011, the IRS and Department of Labor Wage & Hour Division, agreed to work in conjunction to ensure people are being paid properly, paying the correct amount of taxes, and serving the workers best interest by ensuring they are awarded the basic protections and rights as employees. They are now taking their efforts a step further and aligning their efforts with the Fair Labor Standards Act.

By implementing the Six Economic Reality Factors test, it will be easier to determine which their worker should be classified as.


1 – The opportunity for profit or loss

2 – The investments has the worker made

3 – How temporary or permanent is the working relationship expected to last?

4 – How much control is exerted by the employer versus independence of the worker

5 – Would your business still operate without the IC, or are they performing a vital function?

6 – Is the worker able to utilize their skills and initiative, or are they being directed?

*Until the DOL guidance is finalized, it is best to follow the IRS 20 Factor Test.


What next?

Are you concerned, relieved, or nervous? Maybe there’s one or two workers that you’re not quite sure which applies. The IRS and DOL are much more forgiving than their reputation states. There is a ton of material available on the Dept. of Labor and IRS websites on how to become compliant and get a break on past taxes. Or take advantage of the reading and research that’s been done, and call LNJ Employer Services for a free consultation!


Stacy Cooper, SHRM-CP

3/3/2023

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