Employee vs. Contractor: Everything You Need To Consider When Classifying Workers

Men shaking hands on business negotiation.

Today, there are 57 million workers participating in the booming gig economy. That’s a whopping 36% of the entire US workforce—and it’s making the line between independent contractors and employees blurrier than ever before.

If you’re wondering why the distinction even matters, consider Uber’s recent worker classification kerfuffle. Uber has long based its business model on classifying its entire workforce as independent contractors.

But back in 2015, an Uber driver approached the California Labor Commissioner to decide if she was an independent contractor (as Uber claimed) or if she was an employee (as she claimed). The Labor Commissioner ultimately ruled that the driver was an employee and, as a result, was entitled to be reimbursed by Uber for up to $4,152 in expenses.

There’s more at stake than just one Uber driver getting reimbursed for job-related expenses. Employers are responsible for collecting taxes through payroll withholding and are responsible for paying half of Social Security and Medicare taxes, unemployment insurance taxes, and maintaining workers’ compensation insurance. So with over 900,000 active drivers in the United States, Uber could have faced millions of dollars in damages if its drivers were classified as employees.

That’s why, in 2019, the National Labor Relations Board decided once and for all that Uber drivers are not employees but independent contractors instead.

Uber’s story is just one of many examples, and it shows just how vital correctly classifying your workers really is. But for a lot of companies, there’s only one major problem: They don’t know how to correctly classify their workers—or why it even matters.

Here’s how to distinguish employees versus independent contractors—and what’s at stake if you don’t.

When You Hire An Employee

A worker is considered an employee if you control the work they’re tasked with, how it’s done, and when it’s done. The employing company has the right to define, control, and manage these details, and employees who refuse to follow those guidelines put themselves at risk of losing their job.

An employee also has their federal and state taxes, Social Security, and Medicare withheld from their paychecks. Employees are also offered benefits, including paid sick leave, vacation, health insurance, and retirement plans.

As the employer, this means the IRS requires that you file special paperwork for employees. For each employee hired, you’ll need to collect a Social Security number to enter on an annual Form W-2 wage and tax statement, as well as a signed Form W-4 that provides the information needed to calculate the amount of federal income tax to be withheld from each paycheck.

When You Hire An Independent Contractor

In contrast, an independent contractor decides how and when the work will be done. And more often than not, the contract is project-based.

Independent contractors typically set their own hours and are paid as freelancers, either with a flat fee or hourly rate. The duration of their work, their independent project deadlines, and the details of their pay are generally determined by a contract.

As the employer, you’ll need to file a Form 1099, which includes the combined totals for an independent contractor getting paid $600 or more during the previous tax year. It’s also important to note that you won’t withhold any taxes from a contractor’s wages. Instead, independent contractors are responsible for paying their own taxes to the IRS through a process of estimated quarterly taxes.

Independent contractors also aren’t entitled to benefits, making them solely responsible for securing their own medical, dental, and long-term care insurance.

Here’s How The IRS Determines Worker Status

Even though the general classifications seem pretty straightforward, there’s still some grey area. The truth is, there’s no one-size-fits-all way to know if a worker is an independent contractor or employee. That’s because the IRS looks at each situation on a case-by-case basis.

Fortunately, the IRS uses a few guidelines to make the distinction a little more clear, no matter your scenario. You can use those guidelines, too, to see how your workers might fit into your business.

Behavioral Control

If you train and direct the person’s workload, including hours of work, what tools or equipment they should use, specific tasks to be performed, and how the work is to be done, the worker is likely an employee.

If the worker can set their own hours and works with little or no direction, he or she is probably an independent contractor.

Financial Control

Do you control certain aspects of the worker’s finances? This includes things like how and when the worker is paid, whether expenses are reimbursed, and whether or not paid vacation and paid sick leave are offered. If so, your worker is likely an employee.

Here’s another indicator: If your worker is paid on salary, they’re an employee. If the worker is paid a flat fee per project or by the hour (generally at a price the worker sets), they’re probably an independent contractor.

Type of Relationship

Are there written contracts or employee benefits, such as vacation pay, pension plans, or insurance?  If the worker is entitled to benefits, this usually indicates an employment relationship.

Another thing to consider is the type of work the person does. Is their work directly related to the company’s core work? If so, they’re probably an employee. For example, if you run a new tech company and hire a copywriter to build messaging for your new landing page, you’re most likely hiring an independent contractor. But if you’re hiring a software developer to build your core product, that’s a pretty clear indicator they’re an employee.

Repercussions of Misclassifying a Worker

According to the IRS, “There is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.”

Many businesses mistakenly believe this means they have some wiggle room in determining how to classify their workers, but this just isn’t the case. In fact, the IRS estimates that millions of workers have been misclassified, and according to state-level studies, 10-20% of employers misclassify at least one worker as an independent contractor.

Misclassifying workers can be costly, as you’ll be subject to fines and back taxes. On both the federal and state levels, fines can be as much as 100% of the employment tax due. In addition, companies can also be liable for all federal income tax not withheld, all Social Security taxes not withheld, and unemployment tax insurance.

If you’re still in doubt and need help with the classification, you can file a Form SS-8 to request a determination from the IRS. 

Originally published on October 26, 2022, and last edited on February 21, 2023.

Frequently Asked Questions

Looking for answers? You came to the right place. To learn more about our company mission and culture, click the link below.

Life at Swyft
How much does it cost to form a corporation or LLC?

You can form a corporation or LLC with our help for as little as $0, plus state filing fees for incorporation. Filing fees vary depending on the state you incorporate in. For more information on specific states, check out our state guides on the Swyft Resource Center. You can also email us with specific questions or contact us at 877-777-0450.

What payment methods do you accept?

Swyft Filings accepts payment through Visa, MasterCard, American Express, PayPal, checks, and money orders. You can send any questions about payment to our email address or contact us at 877-777-0450.

Will I have to pay additional fees to Swyft Filings after completing my order?

It depends on what you ordered. If all you did was file your corporation or LLC, the price you paid when ordering is all you pay. You will have no further fees after that.

However, if you signed up for the Swyft Filings Registered Agent Service, you will be charged its initial fee three days after you place your order. From then on, you will be charged according to the terms of your subscription until you change your registered agent with the state or dissolve your company. If you change your agent or dissolve your company on your own, let us know so we can discontinue billing.

Other potential subscription-based options include SnapMailbox, 360 Legal Forms, and ComplianceGuard. If you opt for SnapMailbox or 360 Legal Forms, you will be charged a monthly fee after their respective 30-day free trials end. ComplianceGuard has an annual fee after a 14-day free trial. All three of these services are completely optional.

When will my order be processed?

Our team processes all Standard orders on a first come, first served basis. If you opt for Express or Same-Day Processing, we prioritize your order and send it to the front of the line. However, no matter how fast we get it out the door, you’ll still have to wait for your state to address your filing.

Swyft Blog

Everything you need to know about starting your business.

Each and every one of our customers is assigned a personal Business Specialist. You have their direct phone number and email. Have questions? Just call your personal Business Specialist. No need to wait in a pool of phone calls.

Woman in room with flowers in vases.
Preparing to Launch

5 LegalZoom Alternatives for Entrepreneurs

If you’ve considered forming a Limited Liability Company (LLC), corporation, or nonprofit, you’ve probably heard of LegalZoom. This service has helped entrepreneurs with business formation since 2001.
Coffee Shop Owner on Computer
Preparing to Launch

Northwest Registered Agent vs. LegalZoom

Our Northwest Registered Agent vs. LegalZoom comparison reviews each service’s formation time, customer service, and offerings so you make an informed choice.
Nonprofit Spotlight: Bailey's Bookworms' Mission of Literacy
Managing Your Business

Nonprofit Spotlight: Bailey's Bookworms' Mission of Literacy

Swyft Filings is a business formation service that automates the filing process for entrepreneurs, making it easier to get their LLC, C corp, S corp, or nonprofit off the ground. Since 2015, we've helped over 300,000 businesses incorporate.
Blog Card Image
Managing Your Business

What's an Apostille?

Swyft Filings is a business formation service that automates the filing process for entrepreneurs, making it easier to get their LLC, C corp, S corp, or nonprofit off the ground. Since 2015, we've helped over 300,000 businesses incorporate.
zenbusiness vs legalzoom - Swyft Filings

ZenBusiness vs. LegalZoom: Comparing LLC Formation Services

Our ZenBusiness vs. LegalZoom comparison reviews each service’s formation time, customer service, and other features so you make an informed choice.
Setting Up Business Credit
Managing Your Business

How to Get an EIN to Open a Business Bank Account

In most cases, you need an employer identification number to open a business bank account. Follow these steps to get an EIN for your business banking needs

Do what you love. We'll handle the paperwork.

Trusted by over 250,000 businesses since 2015. Start your business with confidence. Affordable. Fast. Simple.

Incorporate now
Dummy Switchback Image