Employee vs. Independent Contractor: Understanding the Difference

Being an employee has its advantages, like having a steady and predictable income, benefits such as health insurance, and coverage by workers’ compensation insurance. But being an independent contractor also has its advantages, such as flexibility, the opportunity to work multiple gigs at the same time, and the freedom to live where one wants. The distinctions between employees and independent contractors are crucial, as failing to appropriately classify workers can expose employers to both legal and tax penalties. A Norfolk employment lawyer can help employers classify their workers correctly and employees seek remedies for misclassification. 

As the Gig Economy Grows, Worker Classification Is Increasingly Important

The categories of employee and independent contractor are not new; both types of workers have long existed in tandem. But over the last decade or so, the number of people working in the gig economy has increased significantly. According to a McKinsey study, 36% of the US workforce was made up of independent contractors in 2022, up from 27% in 2016. That includes workers who are full-time independent contractors and those who are traditionally employed but also have a “side hustle.”

IRS Guidelines for Determining Worker Classification 

The Internal Revenue Service (IRS) oversees worker classification, as a worker’s classification as an employee or independent contractor has significant tax implications. There is no bright-line rule for determining whether a particular worker falls into either category. Rather, the IRS examines the relationship between the payer and the worker.

It does so using the following guidelines: 

Behavioral Control

A worker is an employee when the payer has the right to direct and control the work performed by the worker, even if it does not exercise that right. To determine behavioral control, the IRS looks at the following factors: 

• The type of instructions given, such as when and where to work, what tools to use, and where to purchase supplies and services
• The degree of instruction (more detailed instructions may indicate that the worker is an employee, while less detailed instructions may indicate the opposite) 
• Whether the payer uses an evaluation system to measure the employee’s performance 
• Whether the payer provides on-the-job training to the worker

Financial Control 

A worker may be more likely to be classified as an employee if the payer has the right to direct or control the financial and business aspects of the worker’s job. To determine, financial control, the IRS looks at the following factors: 

• Significant investment in the equipment the worker uses 
• Unreimbursed expenses (independent contractors are more likely to incur unreimbursed expenses than employees)
• Opportunity for profit or loss (often an indication that the worker is an independent contractor)
• Whether the worker is available to seek outside business opportunities
• Method of payment (employees usually are guaranteed an hourly, weekly, or monthly wage, while independent contractors are typically paid by the job) 

Relationship 

The IRS then considers the type of relationship between the parties and how they perceive their interactions with each other. This includes: 

• Employment contracts that describe the relationship the parties intend to create (however, note that a contract stating that a worker is an independent contractor is not sufficient in itself to determine the worker’s status) 
• Whether the payer provides the worker benefits
• The permanency of the relationship 
• Whether the services the worker provides are seen as key to the operation of the business

If you regularly employ gig workers or independent contractors and would like more information about the IRS guidelines, please contact a Norfolk employment lawyer. 

Motivations for Misclassifying Employees as Independent Contractors 

There are many reasons why an employer might attempt to misclassify an employee as an independent contractor. They mostly boil down to cost and administrative savings. Some of the most common motivations for employee misclassification include: 

• Avoiding minimum wage and hour regulations
• Avoiding having to pay Social Security, Medicare, and unemployment insurance taxes
• Circumventing anti-discrimination laws enforced by the Equal Employment Opportunity Commission
• Circumventing the provision of reasonable accommodations under the Americans with Disabilities Act
• Diluting the collective bargaining rights of workers, as independent contractors are not covered under the National Labor Relations Act
• Avoiding having to provide benefits like health insurance
• Avoiding having to verify that workers are U.S. citizens or otherwise entitled to legally work in the U.S. 

While employee misclassification saves employers money, it has steep costs for workers, costing them thousands in lost income and benefits every year. 

The Consequences of Worker Misclassification in Virginia 

The Commonwealth of Virginia takes worker misclassification seriously. As of 2021, all individuals who perform services for another in exchange for payment are presumed to be employees of the party that pays them. The burden then shifts to the payer to prove that a worker is an independent contractor under IRS guidelines. 

Employers in Virginia who are found to have misclassified employees as independent contractors face the following consequences under Virginia law (in addition to federal penalties):  

• Civil penalties: An employer who is found to have misclassified employees is subject to a civil penalty of up to $1,000 per misclassified employee for a first offense, up to $2,500 for a second offense, and up to $5,000 for a third or subsequent offense. 
• Debarment: An employer who is found to have misclassified employees may be restricted from contracting with public bodies and certain other covered institutions for a period of up to three years, depending on how many offenses the employer has committed 

The commonwealth also prohibits employers from requiring employees to sign agreements that mischaracterize the nature of their employment relationship, as well as from retaliating against workers who exercise their rights under Virginia’s employee misclassification laws. 

Avoid Employee Misclassification With Guidance From a Norfolk Employment Lawyer 

The stakes of employee misclassification are high. However, classifying a worker as an employee or independent contractor is more of an art than a science, as the IRS’ guidelines demonstrate. To avoid worker classification mistakes, employers should seek the advice of an experienced attorney. For more information, contact a Norfolk employment lawyer at Pierce / Jewett by calling 757-304-6655 or using our online contact form.