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When deciding whether to use employees or independent contractors, companies often consider cost as a deciding factor. Choosing to use independent contractors over employees appears to be a good choice, as it can decrease certain expenses, such as workers’ compensation insurance, payroll taxes, overtime pay, and minimum wage obligations. While this may be a viable option for many employers, companies should be careful, as both federal and state laws regulate when workers are to be categorized as employees or as independent contractors.

An independent contractor label must be justified and properly documented. If not, companies can be held liable for mislabeling their workers. To avoid this, startup companies need to familiarize themselves with the relevant laws governing worker classification and then structure their independent contractor relationships in a manner that confirms the propriety of this label.

A mere label, however, is not enough to classify a worker as an independent contractor. Various federal and state laws apply different tests to determine the proper classification of a worker. The primary test concerns the amount of control the company exerts over the details of how the worker actually performs his or her job. For example, does the company control not only what the worker produces but how he or she produces it? Does the worker provide tools or resources necessary to complete the job? The more control  an employer has over a worker’s actions, the more likely it will be that the worker will be considered an employee rather than an independent contractor.

Other factors that are used to determine a worker’s classification include integration of the worker’s services with the company’s business, whether the services provided must be rendered personally, how the hours of work are determined, how and how often the work is compensated, whether there are any written contracts or employee benefits, and whether the  individual works for more than one company at a time.

A company should evaluate all of these factors when determining whether a worker is an employee or independent contractor. Misclassifying an employee as an independent contractor can have negative consequences for a startup company and cause  it to be subjected to federal and/or state tax liabilities, including interest and penalties.