So what are the tangible differences between the categories of workers referred to by the industry as subcontractors and independent consultants? And how do those roles differ from permanent employees?
Correctly Classify Workers
We often hear independent consultants being referred to as 1099 employees. This is somewhat misleading, however, because 1099 tax forms will be issued to both subcontractors and independent consultants unless the subcontractor is part of an S or C Corporation. An individual may be working for a company as an independent consultant but based on Department of Labor Fair Labor Standards Act guidelines, they actually may be determined to be an employee. It is vital to differentiate and classify workers correctly, or you could face fines and penalties.
A subcontractor has a separate business entity setup, including a business license and federal identification number or tax ID, and may or may not have employees. We define an "independent consultant" as a person who works for themselves, uses their own Social Security number, and does not have a separate business entity setup.
An employee is a worker who typically performs duties dictated or controlled by others. In most cases, an employee is provided training and tools or equipment to do the job. Employees also may receive company benefits and the employer pays a portion of Social Security and Medicare or state unemployment taxes.
Understand Labor Rights
If a company is working with a legitimate subcontractor, there is little risk. One of the Department of Labor's goals is to protect worker's labor rights. An employee working for a subcontractor is covered by labor laws. For example, within certain parameters depending on the jurisdiction, if someone is employed by a subcontractor and is laid off, they may be eligible for unemployment benefits.
Consider the Path of the Employee
It becomes more confusing when trying to determine whether a person should be classified as an employee or an independent consultant. Many people believe that this is entirely up to how the worker wants to be paid, but it’s not that simple. The Supreme Court ruled that no single factor determines whether a person is an employee or independent consultant but rather this is determined by whether the person “follows the usual path of an employee.” Take into account the following factors when determining whether someone is an independent consultant or employee:
- How integral is the worker to the business? For example, does the worker make hiring decisions or supervise employees? These are generally employee responsibilities.
- Does the worker have other customers? Consultants usually have multiple customers.
- Does the individual have his or her own tools? Consultants usually provide their own supplies, materials, and equipment.
- How long will the worker be engaged with the work effort? If it is a long-term, permanent position, the person often is considered an employee.
Proper classification of all three of these types of workers is key. When classified correctly, your business can avoid exposing itself to cumbersome audits and potential fines and penalties. Combined with a Pay As You Go system of Workers' Comp, properly classifying your employees can help you avoid paying for more than you are actually using.