Much has been written in recent years about “the gig economy” — an environment that favors hiring independent personnel for short-term appointments — and with good reason. According to a recent Princeton University study, the percentage of American workers engaged in “alternative work arrangements” has grown from 10.1 percent in 2005 to 15.8 percent in the year 2015. A study by Intuit predicts that by the year 2020, 40 percent of American workers will be independent contractors.
With more than 9 million independent contractors in the workforce, it’s important for employers to understand the key legal distinctions between these workers and employees — and their responsibilities to each group.
Independent Contractor or Employee?
According to the IRS, “an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.” An individual is considered an employee if the employer controls “the details of how the service will be performed.” As one might imagine, this definition leaves ample room for interpretation; if you are uncertain how to classify certain individuals in your organization, consult your legal counsel immediately (see Penalties for Misclassification below).
For employees, the employer is required to pay Social Security, unemployment insurance and other mandatory compensations. The employer must also compile payroll reports for all employees at the end of the tax year. For independent contractors, the employer is only responsible for issuing an IRS Form 1099 at the end of the tax year to those who have been paid more than $600.
Discrimination and Harassment
Employees are protected by EEOC laws that deal with discrimination and harassment, including laws covering the accommodation of disabilities. Independent contractors are not covered under these laws. However, if an employee harasses an independent contractor because of race, the company may be liable under Section 1981 of the Civil Rights Act of 1866 (that’s right — 1866), which protects minorities’ rights to enter and enforce contracts.
Penalties for Misclassification
Misclassifying an employee as an independent contractor can have serious — and costly — consequences.
If a court rules that an employee has been misclassified, you may be required to:
- Reimburse the individual for wages they would have been paid under the Fair Labor Standards Act (FLSA), including minimum wage and overtime
- Payback taxes and penalties on the federal and state levels, including Social Security, Medicare, and unemployment
- Pay any workers’ compensation benefits that would have been due if the person had been correctly classified
The “gig economy” is expanding to encompass businesses of all sizes in some of the nation’s most prominent industries — including healthcare, construction, and education. Even if you don’t currently hire independent contractors, it’s a good idea to be aware of your responsibilities should the issue arise in the future. For more information, see the IRS page “Independent Contractor (Self-Employed) or Employee?” and the Small Business Administration (SBA) page “Hire a Contractor or an Employee?”