The Pitfalls of Using Independent Contractors Versus Employees in Your Business

IC Agreement

I’ve had so many clients that think they are doing the right thing when they set up their business using independent contractors.   What they do not realize is that it’s not as simple as just saying you’re using independent contractors.   There are a lot of ways to misstep and end up in a lawsuit.   This is probably the most common issue for small businesses and the scariest because of the repercussions for misclassifying an employee.   

The most recent cases that you may remember involved Uber drivers who were classified as independent contractors by the company. The drivers sued Uber on the claim that they are employees, not independent contractors.  The Uber drivers claimed that they were being denied the protections afforded to employees under federal and state laws by being classified as independent contractors.   Because they were independent contractors, Uber did not have to pay the drivers a minimum wage, which is required under federal and state law. Ultimately, Uber has been able to retain its classification for drivers as independent contractors. 

There are pros and cons to being an independent contractor.  They get to set their own hours, are typically paid more per hour than employees because the company doesn’t have to pay any benefits, and no taxes are taken out of their pay (this doesn’t mean that taxes aren’t owed).    The biggest con to being an independent contractor is that you don’t receive any benefits.  There’s no health insurance coverage for independent contractors.  If you want to take vacation or sick leave, there’s no paid time off.  You are not covered under the company’s worker’s compensation insurance.  And not paying taxes can be a problem for those who aren’t disciplined enough to save for their tax bill.  You could be in for a big surprise come tax season when you find out you owe a large sum to the government.   This can be avoided by sending in quarterly payments to the IRS, but for some people that isn’t realistic.    

I would suggest contacting an attorney to make sure you are correctly classifying your employees regardless of if you are just starting out or have been in business for years.  What do you do if you find yourself in a lawsuit or a workers’ compensation case where the party is claiming they are an employee and not an independent contractor?  There is no rigid rule.  It boils down to a list of factors a judge will use to determine the correct classification for the person.   Each case is different as each set of facts differ.  The most heavily weighed factor is the right to control the manner in which the work is done.   An employee is typically subject to the control and supervision of their employer.  An independent contractor is their own boss and thus has control over when, where, and how they work.   There are other factors the court will consider, such as how the person is paid or if you supply their work tools, to name a couple. 

How do you protect yourself and your business if you use independent contractors?  I’ve had a lot of clients who thought they were protected simply by having the person sign a form stating that they are an independent contractor.  This offers little to no protection or guarantee.  As I stated, there are factors that will be considered and just having a form stating the relationship between the parties does not make it so.  If you misclassify an employee as an independent contractor it can end up costing you, a lot.  Your business may not survive because the lawsuit can be brought against the company and you, individually.  You lose the protection of the corporate shield.  This puts your personal assets at risk.  And if it’s done intentionally, you run the risk of criminal charges being brought against you.  

You can submit paperwork to the IRS to have them determine the classification of an independent contractor/employee, but that’s raising a big red flag with the IRS and possibly some unwanted attention.  My suggestion is to consult with an attorney before you start your business or have an attorney review your current practices and advise you accordingly.