Many small businesses rely on independent contractors to get vital work done. And there are plenty of reasons to do so. Independent contractors can help you cut costs and expand your business without having to take on the commitment, expense and liability of employees.

However, this is where some business owners go wrong: They think they’re hiring independent contractors when, in reality, they’re hiring employees. The consequences of such a misclassification can be incredibly costly.

Why it matters

From a legal standpoint, independent contractors are much different from employees. The latter are generally entitled to significant rights and benefits, including:

  • Job-protected leave under the Family and Medical Leave Act
  • Minimum wage and overtime pay (for non-exempt employees) under the Fair Labor Standards Act
  • Workers’ compensation for job-related injuries and illnesses
  • Unemployment benefits
  • Certain rights under anti-discrimination and anti-retaliation laws

By using independent contractors instead of employees, business owners can avoid paying Social Security, unemployment insurance and other expenses. There are also tax advantages to having independent contractors instead of employees.

Understanding the distinction

Given these advantages, it’s no surprise that business owners would much rather have independent contractors than employees. Of course, you can’t simply choose whether to treat someone as an independent contractor or employee. The law sets those definitions.

Literally speaking, the term independent contractor refers to a third party who contracts out their services. Yet gray areas often make it difficult to distinguish contractors from employees.

While there is no simple equation for reaching the right answer, there are several key factors to consider:

  • How much autonomy do your workers have over the job? Independent contractors typically operate under their own guidance, without too much control or oversight by the contracting business. They may provide their own training, tools, materials, equipment and facilities. They may even have their own employees. Independent contractors typically rely on their own judgment and industry expertise to get the job done. Their work is subject to competitive forces in the open market. Independent contractors are often, but not always, separate business organizations – LLCs, partnerships or corporations, for example.
  • How much financial autonomy do your workers have? Rather than simply earning wages, independent contractors make their own profits or suffer their own losses, meaning they take on greater financial risk than employees. Independent contractors may also provide services for multiple businesses – not just yours.
  • What are the terms of the relationship? The work of independent contractors is based on a contract, which may have a definitive end date. They’re more likely to perform temporary or seasonal work. They may also fill in when the contracting business has higher-than-usual demands. By contrast, terms for employees tend to be more long-term and open-ended, but with either party free to end the relationship at will.

Another factor is whether the workers are indispensible to your business. If your operations would grind to a halt without them, they’re more likely to be employees.

Weighing these factors

Ultimately, when it comes to determining whether independent contractors are actually misclassified employees, no single factor is decisive. A lot depends on the unique circumstances at play.

For this reason, whenever you have doubts about whether your workers are independent contractors or employees, it’s wise to consult with an attorney who understands business and employment law. Doing so can spare you countless headaches down the road.