The Benefits and Risks of Hiring Independent Contractors: a Complete Guide for Employers


Hiring independent contractors, often referred to as Freelancers, can provide an appealing solution for your business. Without any big commitments, you can easily increase your workforce in a cost-effective and efficient way. 

However, employing contractors does involve certain rules and regulations, and not complying with these can lead to serious risks like misclassification. In this blog, we will share all details about how to prevent and manage misclassification while creating the perfect relationship with freelancers to make your business thrive. 

The perfect answer to growing demand

Independent contractors have shaped the new workforce model for many businesses, and this is not unexpected. On the contrary: remote working and flexible hours are rapidly gaining ground on a global scale and freelancer workers are the perfect fit. With flexible payment options based on a particular project rather than giving a fixed salary, freelancers offer a plethora of benefits. 

Hiring contractors in compliance with local laws and regulations is of the utmost importance, especially since being incompliant with these rules exposes your company to serious risks. Misclassification is one of the greatest risks for your company. When you misclassify a contractor, this person was hired as a contractor while treated as an employee and this can lead to compensations, tax bills, and other penalties. 

However, employing contract workers comes with a risk of ‘misclassification’. The definition of misclassification states that a business should have treated a worker as an employee, but they have been treating him as a contractor which exposes companies to penalties, tax bills, and compensations. 

The growing popularity of independent contractors

Independent contractors have taken over the workforce model and are becoming a more prominent choice for businesses all around the world. According to statistics by the Freelance Job Platform Upwork, there has been an increase of 4 million freelancers between 2014 and 2019.

While freelancing in the USA constituted 35% of the total workforce in 2019 the pandemic of 2020 forced even more companies to work with independent contractors rather than permanent employees.  With the growing adoption and popularity of freelancers, it is becoming more and more difficult to differentiate between freelance contractors and permanent employees. 

For instance, the state of New York has similar law reforms and obligations imposed on businesses no matter whether they have permanent employees or independent contractors. Although enterprises working with both freelancers as permanent employees are treated equally, they do need to manage the risk associated with misclassification. 

Who Is Considered an Independent Contractor?

Contracts are used in all companies as a term to indicate and protect specific rights. A contract may represent the terms and conditions of a business looking to lease or purchase goods or property. Similarly, it can also enter a contract to get services from individuals. The individuals providing services through such agreements are called independent contractors. 

One of the key differences between an individual contractor and a permanent employee is that contractors work for a company without being associated with it.  A permanent employee is directly associated with the daily operations of the business. 

Even though the difference between these two types of workers is rather clear-cut, in reality, multiple factors can define whether a worker is an independent contractor or an employee.

The Benefits of Engaging Independent Contractors

Cost

One of the key benefits of hiring independent contractors is the eradication of liability. Independent contractors are not entitled to any employment benefits which saves a lot of costs These benefits include housing, pension, insurance, commute, and more. They are not even entitled to paid leaves which is yet another significant benefit for an employer. 

Flexibility

Rather than having a fixed monthly salary, independent contractors get compensation based on the requirements of each project. They can be terminated or employed as per the need of the organization. This becomes extremely beneficial when the enterprise wants to scale up or scale down their working capacity according to different scenarios. 

Compliance

Even though individual contractors are being recognized by all jurisdictions and have been gradually becoming a part of the compliance obligations, they still offer considerable compliance ease when compared to permanent employees. 

The Risks of Hiring Contractors – Employee Misclassification?

Just like any other hiring model, involving freelancers has a fair share of its risks alongside the advantages. After mentioning a few key benefits of hiring individual contractors in the above section, we will also address the dangers associated with it. 

The most significant risk is that your new talent may be classified as a contractor while he should have been treated as an employee. This is known as ‘misclassification’. The concern is that by wrongly classifying staff, the organization is depriving them of their benefits such as pension or paid leaves. 

This also includes the possibility that a company may classify a worker as a contractor to reduce their tax as the independent contractor will be liable to pay their taxes. Since the demand for freelancers is increasing so is the issue of misclassifications. 

Regulators are imposing penalties on businesses that have misclassified their laborer more strictly and therefore, it is imperative to understand if your hire is really a contractor or a permanent employee. 

How to determine if your worker is a contractor or an employee

The classification of an employee can be done by addressing the following three points:

Behavioral Control:

Does the business possess control over the worker even if that right is not exercised?  This control is defined through the type of instructions and the magnitude of instructions given to the employees.

Financial control:

Does the company have control over the financial status or the business of the worker? This is subject to payment criteria where a regular payment is indicated as an employment setup. Moreover, if the worker enjoys the liberty to work elsewhere as a contractor then he is treated as a contractor otherwise he is an employee. 

Relationship:

what is the relationship between the individual and the organization? This relationship is defined through any written contract between the employee and the enterprise, the provision of benefits to the employee by the organization, and the degree of permanence of the job. 

These factors are considered by many countries to differentiate between individual contractors and permanent workers. However, these are not legal conditions. The classification of an employee is subject to different factors depending on the situation and is not influenced by just one factor or definition. 

Managing the Risk of Misclassification

Mentioned below are the top recommendations for managing the risk of misclassification:

  • Create a strategy to manage your workforce: Having a proper strategy to manage the human resource in your organization can help you determine the right proportion of contractors and employees needed. For example, a statistic by Upwork depicts that a suitable proportion to fit business’ needs is 450 permanent employees and 1,100 independent contractors. The determination of such needs can help you classify your employees more accurately.
  • Keep a check on the status of your worker: It is not airtight that an independent contractor remains an independent contractor for your company. You may not realize it, but they could have turned into a permanent employee depending on certain conditions or contractual terms over time. The relationship between the worker and company is dynamic and should be checked regularly to ensure the right classification is done.
  • Outsourcing non-essential functions: Certain functions such as human resources or benefits administration are considered as non-essential and can be outsourced. This outsourcing can reduce the number of permanent employees that your organization will need to hire.
  • Consider a Professional Employer Organization (PEO): A PEO is an `Employer or record’ which makes that the PEO will take care of the tax and compliance obligations for the employees of your enterprise in a specific jurisdiction.

Conclusion

Determining the need for independent contractors and permanent employees along with their required numbers is imperative for an organization and its decisions regarding human resources. The ability to differentiate between an independent contractor and a permanent employee is highly important whether you are expanding internationally or simply adding workforce to scale up your business.