Worker classification: What it means for your business

Photo by Scott Graham on Unsplash

Definition

When you hire someone for your business, that person will fall into one of a few categories. These are called worker classifications: Terms that designate the status of someone’s relationship with your company. Most people you pay are either 1) employees, or 2) contingent workers (also known as independent contractors).

If you are misclassifying workers, you could face penalties––but classifying workers is still somewhat subjective. Below, you’ll learn how to classify workers and avoid making mistakes in the process.

Near the bottom of this page, we’ll discuss what implications this has for global hiring.

Worker classification: Cheat sheet

• How you classify workers depends on your relationship with them. In the United States, someone is usually an independent contractor if you, the payer, can only control the result of the work––not when, or how, the work is done. If you’re directing specific hours and processes for work, the person may be better classified as an employee.
  

• The main difference for employers involves taxes. You’re subject to payroll taxes on your employees and you’ll withhold taxes (income, Medicare, and Social Security) from their paychecks. Independent contractors are responsible for paying their own taxes.
  

• There’s a documentation difference, too. You’ll issue a 1099 to independent contractors and a W-2 to employees.
  

How to avoid misclassifying someone 

Many business owners try to classify workers as independent contractors to avoid payroll tax. This can backfire if the IRS discovers you’ve been misclassifying your employees. As a result, many people fear that they’re making mistakes. But it’s simple if you’re asking the right questions. First, consider these three pillars from the IRS:

1. Behavioral: Do you have the right to control what the worker does and how it’s done?

2. Financial: Are you, the payer, controlling the money-related parts of the worker’s job? This includes things like how the worker gets paid, whether they’re reimbursed for tools and expenses, and whether you’re providing tools and supplies.

3. Type of relationship: Are you providing employee-type benefits––vacations plans, pension, insurance, and more? And, are there written contracts?*

*A written contract does not immediately make someone an employee. It’s just one piece that the IRS uses to help you decide.

There’s a lot of common sense involved here. If you’re answering “yes” to the majority of the questions above, there’s a good chance you should classify your worker as an employee. If you’re answering 50/50 or “no”, they might be an independent contractor. But there’s still some subjectivity here. So, here are two tangible examples to help you think it through.

Example #1

You want a developer to join your remote startup.

• You’ve agreed to pay them a set amount of money per month in exchange for a certain scope of work. 
• You don’t control their hours and they may work with other clients during your relationship. 
• Their work is flexible and you don’t dictate exactly how they should complete work. 
• The developer is expected to pay for their own tools, like a computer and a desk.
  

This developer is likely best classified as an independent contractor.

Example #2: 

You want a developer to join your remote startup. 

• You expect this developer to devote a certain amount of time, per week or month, to your business––or at the minimum, you expect a certain level of output. 
• You expect this developer to attend meetings when asked and ask them to be available for certain hours during the day.
• You pay for the developer’s tools, like a computer and a desk. You’ll pay for other work-related tools and expenses.
• You provide benefits like paid time off and equity in the company.

This developer is likely best classified as an employee.

Much of this is intuitive: You’ll probably know whether the position you’re hiring for is an employee position or an independent contractor position. In other words, it’s unlikely that your entire company will be filled with independent contractors––but it’s almost as likely that everyone you ever work with will be an employee.

Now, let’s cover the specific types of worker classifications

The types of worker classifications

Most people fall into one of two categories: Employees or contingent workers. Here’s a breakdown of the sub-categories in each. Remember: The Department of Labor does not have specific guidelines for full-time or part-time employees. It’s up to each business to decide. But, the IRS has guidelines which we’ve outlined below.

Employees

Full-time employees: The IRS defines full-time employees as people who average at least 130 hours of work per month. If you have more than 50 full-time employees, you’ll be classified as an Applicable Large Employer (ALE). If you run an ALE, you’ll have to provide health coverage for all of your full-time employees.

Part-time employees: These are generally people who work less than 30 hours per week for your company.

Temporary and seasonal employees: If you hire someone for a designated period of time and they fit the bill to be an employee (e.g. their relationship with your business not that of an independent contractor), they are a temporary employee. 

Contingent workers

Contingent worker is an umbrella term to describe freelancers, independent contractors, consultants, and casual workers. These terms are used interchangeably. If you hire a contingent worker, you will not be responsible for withholding their taxes.

Worker classification changes by country

In this article, we’ve covered worker classification in the United States. Many of the general rules are similar across the globe, but they’re not the same. Each country has its own standards for what constitutes an independent contractor or an employee.

But, you’re reading this article on the Panther website (that’s us!). We help companies manage payroll and compliance overseas in just a couple of clicks: You won’t have to spend hundreds of hours and tens of thousands of dollars figuring out how to hire a great candidate who lives abroad.

Learn more about how we help remote-based companies with global payroll and compliance.

Hiring in new countries normally takes a long time and costs lots of money. Not with Panther.

Hiring contractors in new countries normally requires weeks of legal paperwork and research on local compliance laws. With Panther, hiring contractors in 150+ countries just takes a couple of clicks.

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