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Employee vs Contractor: Why It's Important to Know the Difference

Michael Gugel, CPO @ GoCo

by Michael Gugel, CPO @ GoCo - May 13th, 2019

As more companies turn to independent contractors to meet changing demands, the line between employee and contractor can blur

There is a growing trend in the United States and around the world. Thanks to wireless communication, better platforms for collaboration, a growing desire among individuals to work more flexible schedules and employers’ interest in reducing costs, there are more so-called "contingent workers" than ever before. These individuals do not have what society has historically considered secure careers or steady jobs.

As of 2015, the percentage of workers in these categories stood at a staggering 40+ percent, according to the United States Government Accountability Office (GAO). This is an increase from 30 percent a mere 10 years ago. These figures include temp workers hired out by agencies, those who work on-call only, independent contractors and contract company workers. By far the largest percentage of these (at about 13 percent) consists of independent contractors.

Online hiring (and the ability to find clients online) has made it easier for independent contractors to operate in the marketplace. Furthermore, consumers expect results and products on-demand and improvements on the fly, which requires a more agile, tailored workforce. Independent contractors offer an ideal solution to help companies meet these changing demands.

However, as more companies replace a portion of their traditional workforce with independent contractors, and more individuals enter the contingent working game, the line between "employee"and "contractor" can blur. The United States Department of Labor (DOL) is taking measures to add clarity to that line, seeking to quantify boundaries, in part, to protect workers.

Why Correct Classification is Increasingly Important

While independent contracting presents a great opportunity for ambitious workers to find their niche, it also may create a loophole for employers to dodge responsibilities they would have toward an employee. The DOL has made it very clear that it is aware of this tendency, issuing warnings to employers regarding labor protections for employees and non-employees alike. Many of these safety measures fall under the Fair Labor Standards Act (FLSA).

The FLSA addresses numerous matters: minimum wage, overtime pay, record keeping regarding employee time and pay, and child labor, among others. Numerous U.S. Senate and House members have proposed stiffer penalties for employers that violate FLSA provisions through the misclassification of workers, due to the increase in contingent workers in the U.S. The issue is not going to disappear, and employers should ensure they are following FLSA guidelines and correctly classifying workers before such penalties go into effect. Otherwise, they could face heavy future fines.

Investigations under the Department of Labor misclassification Initiative are already under way. Even without stiff penalties, employers can face financial hardship because of misclassification. For example, misclassifications uncovered by the Wage and Hour Division of the Department of Labor in 2015 resulted in more than $74 million in back wages being awarded to more than 100,000 workers across a variety of industries.

Reclassifying Workers

After consulting with your legal counsel and board, if you determine that some of your contractors are, in fact, employees, figuring out how to reclassify them may seem overwhelming. It does not have to be. After all, the IRS and the DOL want your workers classified correctly. Here are a few things you can do to streamline the process.

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1. Understand the Difference Between an Employee and a Contractor

The line is not as clear as you might think. In essence, an employee is economically dependent upon his or her employer. An independent contractor, on the other hand, is in business for himself or herself. While open to interpretation, the Department of Labor considers this a matter of "economic realities," not fine print. Some of the tests administered by the DOL, for example, question whether the employee's role is an integral aspect of the employer's business. Does the individual provide the service you sell or create the product you advertise? Or, does the person work in a support role, such as website design? The former is an employee; the latter is a contractor.

2. Start the Process as Soon as Possible

Common sense dictates that the fewer employees you need to reclassify, the easier it will be. If your company is poised to expand, and you are questioning the classification of your employees, now is the time to investigate (and reclassify, if necessary), not later!

Educate Yourself on What Your New Employees Receive

Before you go through with reclassification, have a system in place to ensure the following:

  •  Classified employees receive minimum wage

  •  Overtime payroll policies are instituted

  •  Unemployment insurance is in place

  •  Workers' compensation issues are addressed

  •  ACA requirements will be met

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