Employees vs. Independent Contractors: What Entrepreneurs Need to Know Before Hiring

Welcome to another episode of Launched & Legal with Dayna Thomas, Esq., entrepreneurship attorney and law firm coach. Launched & Legal is an Atlanta Small Business Network original series dedicated to bringing entrepreneurs and business owners the best practices and tips for strategizing, legalizing, and monetizing their ventures. Today, Dayna discusses how the differences between employees and independent contractors can affect your hiring decisions.

Transcription: 

Dayna Thomas, Esq.:
On today’s show, I’m going to talk about employees versus independent contractors. For any growing business, there will be a point where you will need to hire others to help. It may be a virtual assistant, marketing manager, paralegal, bookkeeper, or any other position to help build the business of your dreams. When you hire that person, how do you know if they should be an employee or an independent contractor? The short answer is it depends, and that’s what we’ll talk about today.

Dayna Thomas, Esq.:
Business owners must be aware to correctly identify whether the individuals providing services for their business are employees or independent contractors. Employment status affects many issues, such as tax implications, employment benefits, and liability. Regarding taxes, generally for employees, you must withhold income taxes, withhold and pay social security and Medicare taxes, and pay federal and state unemployment taxes on wages. Yikes.

Dayna Thomas, Esq.:
However, for independent contractors, you generally do not have to pay or withhold those taxes. Regarding employment benefits, the vast majority of employers are required by federal and/or state law to pay overtime to employees who work more than 40 hours per week, unless that employee is exempt. Independent contractors, however, are not entitled to overtime pay. I know.

Dayna Thomas, Esq.:
In addition, federal law provides certain employees with up to 12 weeks of unpaid job protected leave per year. However, a business is not required to provide that time off for independent contractors. Liability wise, there’s more risk when businesses have employees because an employer can actually be liable for the mistakes of an employee, so long as the employee was acting within the scope of his or her employment. With an independent contractor, generally liability is separate. However, exceptions do apply.

Dayna Thomas, Esq.:
Now, I know what you’re thinking. “I don’t want any employees. I want everyone to be independent contractors.” Unfortunately for us business owners, we don’t really get to choose. It depends on how much control we have over the person working for us. How is control determined? I wish there was a formula or a definition to follow, but there’s not.

Dayna Thomas, Esq.:
There’s no single determining factor for categorizing an individual as an independent contractor or an employee. The IRS has developed a 20 Factor Test to help determine the correct employment status. However, I’ll go over five of the most commonly analyzed factors used to make that determination.

Dayna Thomas, Esq.:
Number one, economic dependence. Number two, the number of businesses the person services. Number three, who sets the working hours. Number four, the type of training, and number five, the level of oversight.

Dayna Thomas, Esq.:
Regarding economic dependence, employees tend to be economically dependent on the employer, meaning they need that employer to make a living. For independent contractors, they’re economically independent. For employees, they tend to work for one employer. With independent contractors, they usually provide services to more than one company.

Dayna Thomas, Esq.:
Employees on one hand, work hours that are set by the employer, but independent contractors usually set their own hours. Regarding training, employers are given training on the job. With independent contractors, there’s no training because they’re expected to know how to do the work. And regarding control, employees tend to work under the control or the direction of their employer, while independent contractors work relatively independently.

Dayna Thomas, Esq.:
I also want to mention that having an independent contractor agreement is good evidence that the worker should be categorized as an independent contractor, rather than an employee because it dictates the control or lack thereof in the working relationship. As an entrepreneur, it’s important for you to know the difference between an independent contractor and an employee, because if categorized incorrectly, you could run into unexpected legal or financial hurdles, or even worse, trouble with the IRS.

Dayna Thomas, Esq.:
Now let’s talk a little more about employees, just in case your analysis of the factors I mentioned sways that way. New entrepreneurs generally don’t have employees when they first start. The most common scenario is one person running the operation and building from the ground up. Over time, as the business grows, it will be important to meet the demands of a flourishing business, and one way to do that is to hire employees.

Dayna Thomas, Esq.:
The expectations that you have for your employees should be clear to avoid disputes or delays that could hinder your business. An employment agreement is a great tool to achieve that. An employment agreement is a contract that sets forth the terms of the relationship between the employer and the employee. Employment agreements are not required. However, in many cases, it provides great benefits to the employer, along with describing the responsibilities of both the employer and the employee.

Dayna Thomas, Esq.:
A good employment agreement should include the following; the duration of the job, the benefits such as health insurance, vacation leave, disability leave that the employee may receive, a non-compete provision, protection for your confidential information and client lists, the grounds for termination, your ownership of the employee’s work product, which is super important, and dispute resolution.

Dayna Thomas, Esq.:
Having an employment agreement with employees can be very useful if you want more control over what the employee can and cannot do. For example, if finding a replacement for your employee will be very costly and time consuming, an employment agreement can require the employee to give you advanced written notice of his or her intent leave.

Dayna Thomas, Esq.:
Although you cannot require an employee to stay and continue to work for you, an employee is likely to comply with a written agreement in order to avoid a penalty. In addition, if the employee will be exposed to confidential information or trade secrets within your business, an employment agreement can require the employee to keep all of that information confidential, and prevent them from using it to their advantage or to the detriment of your business.

Dayna Thomas, Esq.:
For example, if your employees will have access to your customer lists, the employment agreement can prohibit them from using the customer lists in any manner, especially to drive customers away from your business and to theirs.

Dayna Thomas, Esq.:
You can also use employment agreements to entice highly skilled candidates to work for you, instead of the competition. By laying out the terms of your agreement, candidates will feel a stronger sense of job security, which can motivate them to work for you. Employment agreements also allow you to include restrictions on the employee competing with you post-employment.

Dayna Thomas, Esq.:
Employees normally have access to information that they could potentially use to compete with your business. With an employment agreement, you can include a non-compete provision, which can prevent the employee from either working for a competitor or starting a competing business of their own. The key to having an enforceable non-compete provision is making sure that it’s reasonable in duration and scope.

Dayna Thomas, Esq.:
The reasonableness of duration will depend on the facts of each situation, but generally a reasonable duration is how long the threat to your business lasts. Some states have a maximum time period, such as two years. Scope includes what’s being restricted and the geographic location in which the restriction applies, which must also be reasonable.

Dayna Thomas, Esq.:
For example, if your business has one location in a small town and the job requires low skill level and minimal access to confidential information, it may not even be necessary to have a non-compete provision. However, if you have several business locations on the East Coast and the job is for a high-level employee who makes strategic business decisions on a daily basis, then a non-compete provision will likely be enforceable in that region. Of course, when determining legal requirements as an employer, be sure to consult with an attorney in your state that can help.

Dayna Thomas, Esq.:
Well, I hope today’s show helped to educate and inspire you as you pursue your business goals. Be sure to share today’s show with someone who can benefit and visit MyASBN.com and subscribe. If you have any questions or comments about today’s show, I would love to hear from you, send me a message or comment on Instagram at @daynathomaslaw. Remember to tune in next week and every week to make sure your business is launched and legal.


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