- Hi everyone, I'm attorney Aiden Durham
with 180 Law Co in Colorado
and you are watching All Up in Yo' Business.
(guitar music)
On this episode of All Up in Yo' Business,
we're gonna talk about the differences
between employees and independent contractors,
why it's important to understand the difference
and how to make sure you are properly classifying
somebody who performs work for you or your business.
But before we get into it,
please be sure to like, subscribe and share
and check the description for links
to additional information and resources.
In my last video, I talked about independent contractors,
freelancers, and gig workers
and how the terms really all mean the same thing,
which is self-employed and not an employee of somebody else.
In that video,
I explained that when you perform work for someone else,
you can be one of two things.
You're either an employee
or you're an independent contractor.
It's important to know how they differ
because employees inherently have certain rights
that contractors often don't have
and employers have certain duties
and obligations to their employees,
which they typically don't have to contractors.
As an employer or a company,
if you hire someone to do work for you,
you must be sure to properly classify that worker
as either an employee or an independent contractor.
It's not so much a big deal
if you classify somebody as an employee
when they're really an independent contractor.
You may take on more responsibility
and obligations that you really don't need to,
but you're not going to get in the same kind of trouble
that you would if you classified someone as a contractor
when they really should be an employee.
If you misclassify an employee as an independent contractor,
you could be liable to the IRS for employment taxes
for that employee.
You could also be liable under state and federal labor laws
such as the FLSA or Fair Labor Standards Act.
You also risk being liable for things
you may not have anticipated or planned for
such as workers' compensation claims
or liability for your employees' actions
under the legal doctrine of respondeat superior.
So needless to say, it is really important
that you understand the differences
between an employee and an independent contractor
so you can properly classify the people
who work for you or your business.
Now, what makes it even more difficult
is that there's no bright line rule
or standard for making that determination.
Sometimes it's pretty clear and obvious,
but more often than not,
it's kind of in this gray area of well,
they're kind of like an independent contractor
in one respect,
but kind of like an employee in another respect.
We have to weigh the different factors
and basically just make an educated guess
in a lot of situations.
What's even worse is that there are a handful
of different laws at play when it comes to determining
if someone is an independent contractor or an employee.
Not only do we not have a clear rule or standard,
but we've also got different rules
that come from different jurisdictions and governing bodies.
We've got to worry about state laws.
Each state has its own laws regarding
what makes someone an independent contractor
versus an employee and their own laws regarding the rights
of employees and contractors.
And in most cases,
it's the state where the worker is located
that we have to worry about,
not just the state
where the company is located or registered.
We also have to worry about federal laws.
Not just the states,
but the federal government has its own rules
about what makes somebody an independent contractor.
And we also have the IRS's rules.
Now, I mean, the IRS is still technically
part of the federal government, but they have their own set
of rules and standards and punishments and penalties
when it comes to classifying workers
as employees or independent contractors.
So even if it's clear
that somebody is an independent contractor
according to the IRS, that doesn't necessarily mean
that they'll be an independent contractor
according to the state
or the United States Department of Labor.
Because there is so much at play here,
I'm gonna split this up into two, maybe three videos.
This video could easily be over an hour
if I talked about all of it.
I'm also not gonna be able to break down
the different laws of each state.
Like I said, each state has its own set of rules.
Some state rules are really similar
but there are some outliers.
I'm looking at you, California and New York.
Because of all of that,
you should always consult with a lawyer who is licensed
in your state or in the state where the worker is located
for specific legal advice.
In this first video, I'm gonna start with the IRS rules
because those are based on kind of common law principles
and I think they give you a good starting point
of understanding kind of the basics
of what makes someone a contractor rather than employee.
I'll talk about the other federal laws
and some state laws in the next video or videos.
Heads up, like I said, there's a lot here.
I'm gonna do my best to break it all down for you
but you're probably gonna want to grab a pen
and paper and take some notes.
So when it comes to the IRS, overall big picture,
it comes down to the degree of control and independence.
How much control does the company have over the worker
versus how much independence does the worker have?
There are three categories that the IRS focuses on:
Behavioral, financial and type of relationship.
Behavioral control refers to
whether there is a right to direct or control
how the worker does the work.
The more right the company has to direct
and control the worker, the more likely that it is
that the worker is an employee rather than a contractor.
With behavioral control, the IRS will look at four factors:
Type of instruction given,
degree of instruction, evaluation systems, and training.
With the type of instruction given,
more instruction means it's more likely to be
an employee relationship.
Instructions such as when and where to perform the work,
what tools or equipment to use,
who the worker can hire or have assist with the work,
where to purchase supplies and services,
what work must be performed by a specific individual,
what order or sequence to follow when performing the work.
They'll also look at the degree of instructions.
More detailed instructions
means the company is exercising more control
and therefore more likely the worker is an employee.
Less detailed instructions on the other hand
reflects less control,
indicating that the worker is more likely a contractor.
The IRS also takes into account the evaluation system.
If a worker is being evaluated on how they perform the work,
then that's more likely an employee.
But if the evaluation is more focused on the end result,
then it may be more likely an independent contractor.
Training also comes into play.
More training means the company wants the work
to be performed in a specific way
and leans more towards the employee thing.
Independent contractors, however,
typically use their own methods and processes
and will require a little or no training at all.
So that's the behavioral category that the IRS looks at,
but they're also gonna look at the financial control
that the company may have over the worker,
whether or not the business has the right to
control the economic aspects of the job.
Independent contractors often have a significant investment
in the tools and equipment that they use
in performing work for someone else.
There's no like specific dollar amount
or anything like that that applies.
And the fact that there has not
been a significant investment doesn't necessarily mean
the worker isn't an independent contractor.
Contractors are also more likely to have
unreimbursed expenses than employees.
A lot of those expenses are fixed ongoing costs
that the contractor has to pay
regardless of the work that's being performed.
Another important factor is the worker's opportunity
for profit or loss.
If a worker has made a significant investment in the tools
and equipment they use and they have unreimbursed expenses,
then there's a greater chance
that the expenses will exceed the income that they'd make.
So the possibility of incurring a loss is a strong indicator
that the worker is an independent contractor.
They'll also look at if the worker makes their services
available to the market.
Contractors are generally free
to seek out business opportunities.
They'll advertise their services,
they'll maintain a visible business presence
and they will seek to be available to work in the market.
Lastly, they'll look at the method of payment.
This factor is usually less important
than a lot of the others.
Employees are often paid an hourly rate or a regular salary
whereas contractors more commonly are paid like a flat fee.
But like I said, this factor isn't always that relevant.
Lawyers, for example, commonly get paid an hourly rate.
So just because you're paid hourly
doesn't mean automatically that you're an employee.
It's just one more factor that the IRS will look at.
The third category the IRS takes into consideration
in addition to behavioral and financial aspects
is how the worker and the company
perceive their relationship with each other.
They'll look at things like written contracts,
employee benefits, permanency of the relationship
and if the services provided
are a key aspect of the business.
If there is a contract that states that the worker
is an independent contractor, that may help to demonstrate
that it is actually an independent contractor relationship,
but just because you have a contract that says that
doesn't mean that's going to control.
Again, it's just one additional factor.
Companies don't typically offer things like insurance,
pension plans, paid vacations or sick days
or other benefits to contractors.
That's usually more of an employee thing.
Employees typically work
for an undefined or indefinite period
whereas contractors are often hired
for a specific project or defined term.
Most states are at will employment states.
We're hiring you until we fire you or until you quit.
If the worker is hired for an unspecified period,
that can usually lean more towards them being an employee
versus if they're hired for one specific project
or if it's specified that the relationship will end
after X amount of months or years or at a specific date.
Lastly, the IRS will look at the services
that the worker provides in relation
to the company's business activities.
If a worker provides services that are a key aspect
of the business, it's more likely that the business
will have the right to direct
and control the worker's activities.
For example, if you're a graphic designer
and you hire someone to help with graphic design,
that service that the worker is providing
is the primary activity that your business provides.
That's not the case if you hire say a bookkeeper.
Your business provides graphic design services,
not bookkeeping services.
So the services that the worker performs are not key aspects
of your business.
Or I'll use myself as an example.
I am a lawyer and I own my own law firm.
If I hire another lawyer to help me with legal work
that I provide to my clients, that's probably gonna be more
on the employee side of the situation
because that is a key aspect of my business,
but the person that I hired to design my website,
web design isn't a key aspect of my business services
so it's more likely
that they would be an independent contractor.
Like I said in the beginning,
we have to weigh all of these different factors.
Just because the worker's services
aren't a key aspect of my business
doesn't automatically mean they're an independent contractor
or just because I give the worker access
to one of my programs or systems and train them
on how to use the program,
that doesn't automatically mean that they're an employee.
It's just one little factor that may be considered
along with all of the other ones.
There's no one factor
or one thing that is particularly more important
than the others.
And it's very rarely a black and white yes or no
employee or contractor situation.
It's more of like a sliding scale
of given these circumstances,
it's more on the independent contractor side
or more on the employee side.
We really have to look at all of the details
of the relationship on a case by case basis
and determine where we land on that scale.
The approach that I like to take with my clients
is starting with situations where the answer
is pretty obvious.
I use myself as an example.
When I do work for my clients,
I'm pretty clearly an independent contractor.
I advertise and offer my services to a wide range of people.
My clients may hire me to draft a contract
and they might tell me specific things
that they need in the contract,
but I'm in complete control of when,
where and how I go about drafting that contract.
My engagement letter with my clients
spells out the specific project or matter
that I'll be assisting them with
though sometimes it's more
of an ongoing relationship where we agree
that I'll be available for them as needed.
Sometimes my clients pay for outside fees
or expenses associated with their matter,
but all of my other expenses, my computer equipment,
my software, my utilities, and other overhead expenses,
those I have to pay for regardless of the work
that I'm performing for a client.
So if I am counseling a client on
whether the person they're hiring is an employee
or an independent contractor, I'll tell them
let's start with my role with your company.
I'm pretty clearly on the far end
of that independent contractors scale.
So let's compare that
with the circumstances of this new worker
and see where that moves us to on the scale.
I also like to tell my clients to think about
what it feels like.
I'm not much of a feelings person,
I like to stick with facts
and how do these facts logically fit into the rules
or laws that were given.
But sometimes especially in this kind of a situation,
we can focus on the facts and logic,
but still not have a clear answer.
So we might have to think more about our feelings
and gut instincts.
Does this person feel like an employee,
do you feel like you had a lot of control
and direction over them?
Lastly, if it's still totally unclear,
if we've weighed all the factors and feelings about it
and we're still right in the middle
of that employee contractor scale,
I like to just err on the side of caution.
If we're really unsure,
then let's just call them an employee.
Sure, there are more obligations
with an employee and it often ends up costing a bit more
to hire someone as an employee,
but the consequences of classifying someone
as an employee when they may actually be
an independent contractor are much, much less
than the other way around.
We're not really gonna get into a lot of trouble
if we treat someone as an employee,
but we can find ourselves in a lot of hot water
if we treat someone as a contractor
when they should have been an employee.
Whew, I told you guys that was a lot.
To summarize, when it comes to determining
if someone is an employee or an independent contractor,
the IRS will focus on the behavioral,
financial and relationship aspects to weigh the degree
of control and independence.
Stay tuned for the next episode
or episodes to learn about how the states
and federal government approach worker classification
and if someone is an independent contractor or an employee.
That's all for this episode, folks.
Drop a comment below, let me know what you think
and again, don't forget to check the description
for links to additional information and resources.
And of course, you should always consult
with a lawyer who is licensed in your state
if you need assistance with determining
if somebody is an employee or an independent contractor
or in determining if you are an employee
or an independent contractor.
Do not just rely on the things
that you see for free on the internet.
Every situation is different and it always depends.
Thank you all so much for watching.
I'm Aiden Durham and I'll see you next time.
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