How to Classify Freelancers, Employees, and Independent Contractors

Pedro Ponce | Jun 17, 2020 | minute read

The American workforce is changing. Until recently, most workers pursued a single, long-term position at a company where they would stay for years, if not decades. While these more traditional career tracks still exist, many more workers are now foregoing being an employee and opting for freelance or independent contractor work. 

As of today, more than 57.3 million Americans — over 36% of the workforce — are freelancers or independent contractors. By 2027, it’s predicted that over half of the American workforce will have gone in that direction. 

How you classify those doing work for your affects the financial and legal obligations that you have to the workers and to the government - making distinction between freelancers, independent contractors, and employees is more important now than ever for your business. 

In this post, we help you navigate the different classifications that might apply to your workforce, and also explain why the different classifications matter so much for your company.

Identifying Whether You’re Working with a Freelancer, Independent Contractor, or Employee

There are three primary types of workers that your company is likely to hire: freelancers, independent contractors, and employees. Employees receive the greatest amount of protection, and require you to comply with numerous government regulations. Let’s discuss the different categories so that you can understand what type of worker you’ve hired. 

Freelancers Versus Independent Contractors

While you’ll likely see and hear the term freelancer being used interchangeably with independent contractor, there are some key differences between the two. Characteristics of freelancers include the following: 

  • Self-employed: Self-employed people don’t work for a specific employer. Instead,  self-employed people, earn income by directly contracting with a trade or business.

  • Pay own self-employment taxes: Unlike employees, whose company’s withhold taxes on their behalf and also pay additional taxes, all self-employed people pay their own self-employment taxes.

  • Set own project or hourly rates: Typically, freelancers set project and hourly rates ahead of time with their prospect client. The projects have agreed upon outcomes and deadlines.

  • No employees: While freelancers don’t have employees of their own, absent a stipulation otherwise in a client contract, they can choose to subcontract their work to others.

  • Autonomy: Freelancers have complete control over the work and clients they choose to take on, and the can typically work from wherever they choose. The client does not control the work process.

Like freelancers, independent contractors work with a similar level of autonomy. The main difference between the two categories is that independent contractors tend to work with one company at a time for an extended period. From the perspective of your company’s legal obligations, your company owes a freelancer the same type of protection that an independent contractor—as opposed to an employee—receives. 

Independent Contractor Versus Employee

The distinction between independent contractor and employee is so important that the IRS even provides specific information on how to make that determination. Unfortunately, whether someone is an employee or independent contractor isn’t a clear-cut analysis. The category that someone falls into is determined on a case-by-case basis through a multi-factor analysis. When determining which category one of your workers falls into, look at the following: 

  • Behavioral control: A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised. Behavioral control categories are:

  • Type of instructions given: The more detailed the instructions are to workers, such as when and where they can work, what tools to use, or where to purchase supplies and services, the more likely the worker is an employee. 

  • Type of evaluation systems: When a company only measures or evaluates the end results of a project, as opposed to the details of how the work was one, then the worker is more likely to be an independent contractor.

  • Training provided: Training a worker on how to do the job indicates that a worker is an employee.

  •  Financial Control: Financial control looks at whether a business has a right to direct or control the business aspects of a worker’s job. Look at the following:

    • Unreimbursed expenses: Independent contractors are more likely to incur unreimbursed expenses than employees.

    • Limiting what services the independent contractor can provide to others: Independent contractors are generally free to seek out business opportunities.

    • Method of payment: An employee is generally guaranteed a regular wage, while independent contractors are most often paid for the job by a flat fee.

  •  Relationship: This factor looks at how the worker and company perceive the nature of the relationship. You’ll want to keep the following in mind: 

    • Description of the relationship in written contracts.

    • Extent of benefits, including insurance, vacation pay, and sick leave provided.

    • Permanency of relationship.

Why the Freelancer, Employee, Independent Contractor Classification Matters

As a business owner, you need to know whether someone working for you is an employee. If you misclassify a worker, you may mistakenly fail to pay Social Security, Medicare taxes, and unemployment taxes. If you don’t set aside the right amount of money, then you could get hit with a tax bill that could make it difficult to meet your monthly financial obligations. 

What’s more, if you have employees, you must have Workers’ Compensation Insurance. In the state of California, you can even face criminal penalties when you fail to do get it

Leap | Carpenter | Kemps Insurance Agency Can Help With Your Insurance Needs

At Leap | Carpenter | Kemps Insurance Agency, we know the importance of understanding who your employees are and how to meet their needs (as well as your own legal obligations). Whether you’re looking for help for Employment Practices Liability, a Workers’ Compensation Policy, or health insurance plans, we have you covered. Contact one of our knowledgeable agents today.

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About The Author

Pedro Ponce is a Commercial Insurance & Risk Advisor who has been representing his customers for over ten years. He holds a Certified Insurance Counselor designation and is currently working on becoming a Certified Risk Manager.

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