Why the Independent Contractor Shortcut for Temporary Workers Could Cost You Big
As a small business owner, you may find yourself in situations where you need to bring on additional staff quickly to meet a sudden increase in demand or to cover a short-term project. You may need extra hands for a new product launch, seasonal rush, special project, or to cover for an employee on leave. In these cases, you might be wondering if you can simply hire these temporary workers as independent contractors for ease. The answer, unfortunately, isn't a simple yes or no. Here's what you need to know:
Understand the Distinction
First, it's critical to understand that the classification of workers as employees or independent contractors isn't just a matter of preference (please read that again!). It's a legal distinction with significant implications for taxes, benefits, and labor laws. Both the Internal Revenue Service (IRS) and the U.S. Department of Labor’s (DOL) Wage & Hour Law Division enforce misclassification of workers in the U.S. For purposes of this blog post, we will be reviewing the IRS’ test. You can read more about the DOL’s test here. It’s also important to also recognize that specific U.S. states also enforce their own misclassification regulations as well, so be sure to check your state requirements.
The main distinction between an employee and an independent contractor is control. Independent contractors are self-employed professionals who offer services to businesses and work under their own terms. They have greater autonomy over how, when, and where they complete their work. In contrast, employees typically work under the direct control and supervision of their employer, following set hours, tasks, and company policies.
The IRS Guidelines
Per the IRS, businesses must withhold federal income taxes, social security taxes, Medicare taxes, and state income taxes (in certain states) from wages paid to an employee. Businesses must also pay the employer portion of social security, Medicare taxes, and unemployment tax on wages paid to an employee. Generally, you do not withhold or pay any taxes on payments to independent contractors, and this is what makes independent contractors an attractive option for small businesses.
The IRS provides guidelines to help determine whether a worker should be classified as an employee or an independent contractor. We have summarized this information in the below infographic also. These guidelines are referred to as a “common law” test that focuses on three main categories:
1. Behavioral control:
Does your business control how, when, and where the work is done? If you dictate specific tasks, methods, and schedules, the worker is likely an employee.
2. Financial control:
Does the worker have a significant investment in their tools or equipment? If you do not provide equipment or tools, the worker is likely an independent contractor.
Is the worker paid by the project instead of hourly or by salary? If you pay the person on a project basis, the person is likely an independent contractor.
Does the person invoice you to be paid? If the person performs the work, then sends you an invoice to be paid, the worker is likely an independent contractor.
Do you reimburse the worker’s expenses? If you reimburse the person for expenses, then the worker is likely an employee.
3. Type of relationship:
Are there written contracts? If you have a written contract establishing the scope of work for a pre-determined amount of time before completing the work, the worker is likely an independent contractor.
Are benefits like health insurance, retirement, or paid time off provided? A continuing relationship with benefits is typically characteristic of an employee.
Is the work ongoing and a key aspect of your business instead of project-based? If so, the worker is likely an employee.
Each factor carries weight, but no single factor determines classification on its own. Ultimately, the overall nature of the relationship is considered. See our previous blog post and the infographic below where we break down the differences between employees and independent contractors in more detail.
Infographic showing the differences between employees and independent contractors.
Misclassification Risks
If you’re considering classifying temporary workers as independent contractors simply because you need help quickly, proceed with caution. Misclassifying employees as independent contractors is one of the most common legal issues small businesses face and it can lead to significant consequences. It's not a risk worth taking just for short-term convenience. Some consequences to expect:
Fines and Penalties: Federal and state agencies, including the IRS, can impose hefty fines for misclassification.
Back Wages and Benefits: If workers are reclassified as employees, your business could be liable for unpaid wages, overtime, benefits, and employment taxes.
Lawsuits: Workers who believe they’ve been misclassified can file lawsuits, leading to legal fees and potential damages.
Here are some real and recent examples of companies caught in the misclassification storm:
Clowns.com was sued December 2023 by clowns and other children’s entertainers under federal and state law for independent contractor misclassification.
LiveXchange Technologies, Inc. was sued for over $3 million July 2024 by customer service agents under federal and state law for independent contractor misclassification.
Select One, Inc. was sued for $3 million July 2024 by drivers under federal and state law for independent contractor misclassification.
Power Design settled an independent contractor misclassification case in July 2024 brought by electrical workers and will pay $1.742 million to the affected workers, $1.128 million in penalties to the District of Columbia, and $880,000 in legal fees.
C&G HVAC, LLC was sued July 2024 by technicians for $1.5 million under federal law for independent contractor misclassification.
It’s critical to ensure that any temporary staff you classify as independent contractors truly meet the legal definition to avoid these risks.
When You CAN Use Independent Contractors
You can hire independent contractors for temporary work if the nature of the work truly fits the independent contractor model. This typically means:
You need specialized expertise for a short-term project.
The worker has control over how they complete the work.
The work is not central to your business’s day-to-day operations.
They use their own tools and equipment.
They offer similar services to other businesses.
You do not need to provide ongoing training, benefits, or resources.
For example, hiring a graphic designer to create marketing materials for a specific campaign or bringing in a consultant for a few weeks to help with a business strategy are appropriate scenarios for hiring independent contractors.
Alternatives for Quick, Temporary Staffing
Establishing the employment relationship as temporary BEFORE the work begins is critical. If you need temporary staff quickly and the work doesn't fit the independent contractor model, consider these alternatives:
Temporary Staffing Agencies: Work with a staffing agency that can quickly provide vetted temporary employees. The agency handles payroll and benefits, reducing your administrative burden reducing your liability as an employer.
Seasonal Workers: If your need is seasonal, you can hire employees under a temporary employment contract that ends at the close of the busy period.
Direct Hire: Hire the employee directly for a specific duration or until a project is complete. Clearly define the terms in a temporary employment agreement.
Internship programs: Hire interns for project-based work to gain experience, especially if you can partner with local universities. See our previous blog post about the legal considerations when employing interns and how to establish an internship program.
Suggested Reading
If your need for temporary staff involves more control, ongoing work, or tasks that are central to your business, it’s safer to classify the workers as temporary employees rather than independent contractors. Temporary employees may still offer the flexibility you need but come with the appropriate protections for both your business and the worker. Be sure to ensure the temporary timeframe is determined and agreed upon up front in writing.
When in Doubt, Consult an Expert
If you're unsure about how to classify a worker, it's always best to consult with an employment lawyer or HR expert such as CPR. The cost of this consultation is far less than the potential penalties for misclassification.
Conclusion
While hiring independent contractors might seem like a quick and easy solution for temporary staffing needs, it's not always the right or legal choice. Take the time to understand the nature of the work and the worker's relationship to your business before making a decision. Remember, it's always better to err on the side of caution when it comes to worker classification. In the end, choosing the right classification ensures you get the help you need while protecting your business from unexpected liabilities.
Disclaimer: The information provided on this website does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. Information on this website may not constitute the most up-to-date legal or other information.
