Employee or contract worker: It's a fine line

Published online on Tuesday, Sep. 08, 2009

As the economy begins to show slight improvement, the market for independent contractors brightens.

Currently, about 4% of workers used by small businesses are self-employed, or independent contractors, rather than employees.

For large businesses, too, it's generally accepted that as needs mount, companies tend to take the cautious route and bring on contract workers rather than jump to add payroll employees.

But one legal expert says there's a "notorious line" between contractor and employee. When crossed, that line can spell lawsuits for the employer and disadvantage for the worker.

An example is an extended dispute between FedEx Ground and its drivers, who are independent contractors. Attorneys general in eight states this summer asked FedEx to consider changing its business model.

At issue is whether FedEx correctly classified its drivers as independent contractors or whether they're employees according to Internal Revenue Service tax rules.

Analysts estimate that employers can save 30% on worker costs by using independent contractors instead of employees. The difference lies in taxes and benefits.

Employers withhold income taxes, pay Social Security and Medicare taxes, and pay into workers' compensation and unemployment funds for employees. Independent contractors are responsible for paying their own taxes and insurance.

Many employers also have the added cost of discretionary benefits, such as employer-subsidized health insurance, life insurance and paid vacations. And they have to pay overtime when due. With independent contractors, those employer expenses go away.

That "notorious line" can be fuzzy. The IRS previously used a "20 factors" test to detail the difference between employees and independent contractors.

Business operators said those rules were confusing, and they campaigned for about two decades to get clearer definitions.

The IRS usually rules that workers are independent contractors if they:

* Can earn a profit or incur a loss while doing the job.

* Furnish their own tools or materials.

* Are paid by the job (not with a salary).

* Could work for more than one employer at the same time.

* Pay their own travel and business expenses.

* Can hire their own assistants or workers.

* Can set their own working hours.

Correctly defined, independent contractors control the means and methods to accomplish the work. The drawback: They have fewer labor law protections than employees.