January 15, 2018

Independent contractor or employee? It’s complicated

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Is it better to hire an independent contractor or bring someone on as an employee? If I had a dollar for every time a business owner asked me this…

The answer? It depends. The exact answer I know you all hate but hear me out on this.

First the business drivers. On the one hand, many business owners want to know which scenario is most economically advantageous to them, like lower overhead or not having to pay employee benefits (among other costs). On the other hand, I know many business owners who eschew independent contractors, viewing loyal, salaried employees as the foundation for building success and more importantly CULTURE.

Then of course there are the legal concerns. There is real risk in making the wrong call including sizeable penalties. This is not an area you should venture into by yourself or, worse yet, use the information in this article to make a call.  It is very-specific to your business but in short, the more control a company has and the less financial risk the contractor has, the more they look like an employee and less like a 1099 worker.

Here’s a quick rundown of the pros and cons of independent contractors (a.k.a. 1099s) vs. employees:

Employee pros: loyalty and commitment; control; ability to build a unique culture; collaborative work environment.

Employee cons: Stress to meet weekly payroll; increased overhead, including purchasing of all tools and supplies; payment of employee benefits; payment of employee taxes; managerial demands.

Independent contractor pros: lower (or zero) overhead; no payment of health benefits (and other benefits); flexibility to hire as workload demands; no need for training, onboarding, etc.  More and more workers actual prefer this flexibility.

Independent contractor cons: less control of worker and work product; risk of getting dinged by IRS.

To the last point, hiring independent contractors has its benefits but if you are caught treating a contractor like an employee, you could be penalized, in a big way, by the IRS. Several years ago the Department of Labor (DOL) established guidelines, an aptly named “economic realities” test (http://webapps.dol.gov/elaws/whd/flsa/docs/contractors.asp), to determine whether an employment relationship exists, as opposed to an independent contractor relationship.

Below are the six general distinctions to consider, from the perspective of the DOL, the IRS and the National Labor Relations Board. I strongly advise you look at the government’s website for a thorough explanation and then ask your employment lawyer for help. (https://www.dol.gov/whd/regs/compliance/whdfs13.htm)

1. How integral the work is to the business

2. The permanency of the worker’s relationship with the company

3. The worker’s and employer’s investments in things like equipment

4. How much control the worker has

5. The worker’s opportunity for profit and loss

6. How much skill is required to do the job and the worker’s initiative

Distinct from federal independent contractor tests and in direct response to the DOL stance, the State of Arizona enacted a statute (A.R.S. § 23-1601) passed by the legislature in August 2016 that offers employers at least a little coverage. In Arizona, employers may confirm the independent contractor relationship by having workers sign declarations that create a rebuttable presumption they have made the right call that an independent contractor relationship exists. The 1099 workers sign a declaration which includes a laundry list of factors including:

That the person is an independent contractor, not an employee of the company

Is not entitled to unemployment or other benefits afforded to employees

Is not covered under the company's workers' compensation insurance

Is permitted to accept work from other businesses

Is responsible for supplying his or her own tools and complying with licensing requirements

Is responsible for paying business-related expenses and income taxes

Is authorized to determine the days and time the work is performed—but the company may impose quality standards and performance deadlines

Now, you don’t need to use this declaration but there is a benefit. Should an independent contractor challenge it, it is their burden, not yours, to overcome the presumption.

Business owners should use these factors to help determine whether or not they should go the independent contractor route or hire employees. I can’t stress enough, however, that these tests are confusing and the analysis needs to be done carefully.

Hiring an independent contractor or new employee is an important business decision. To make the right decision, consider all of the pros and cons. I’m available to answer any questions you may have.


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