The Difference Between Sub-Contractors and Employees

The Difference Between Sub-Contractors and Employees

This is a very important area of employment law, and far too many business owners cut corners in this area and don’t think it’s a big deal-  IT IS a big deal.  How you classify a ‘worker’ in your business, whether as an employee or sub-contractor, can have far reaching effects to you AND your business.

I understand the business owner’s plight.  Many entrepreneurs are wary of the costs and extra paperwork to bring on an ‘employee’ in the business.   Terms such as SUTA, FUTA, FICA and Workers Compensation will often times deter the employer into making the ‘right’ decision, and it could ultimately be devastating to their business.

Bottom line, some business’s try and treat their “employees” as “sub-contractors” and 1099 them rather than set up payroll and follow the proper procedures when hiring an employee.

The IRS consistently warns taxpayers that if they are caught paying ‘employees’ as ‘sub-contractors’, they will pay stiff penalties on top of the taxes and interest owing for payroll withholdings that should have taken place.

Also, what happens if one of your employee gets hurt on the job picking up a delivery or even slipping and falling at your workplace? Can they make a Workers Comp claim that comes to your rescue to pay the medical bills? No. Because you don’t have Workers Comp! You treated them as a sub-contractor and so now you face personal liability and the piercing of the corporate veil because you were negligent in your management of the business and employment practices. This could actually be far more devastating than an audit because claims for medical costs or pain and suffering could easily exceed a tax or penalty.

There are facts and circumstances most commonly used to determine the difference between an employee and sub-contractor. It’s a 3 part subjective analysis and some facts may indicate that a ‘worker’ is an employee, while other factors indicate that the worker is actually a sub-contractor.  Thus, you need to weigh the issues with your tax or legal advisor to make the right decision and what path you’re going to take.

The 3 most common factors or categories used by government agencies around the country, including the IRS, to determine whether a sub-contractor is really an employee:

  1. Behavior of the ‘worker’ in relationship to your direction and guidance. Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial terms between you and the ‘worker’.  What are the business aspects of the financial relationship? Is the worker paid hourly or weekly?  Does it look more like pay that an employee would receive?  Do you reimburse for expenses and provide the work space, tools and supplies?
  3. Type of Relationship in writing AND Understanding.  Would your ‘worker’ consider themselves an employee?  Could they be fired any particular day?  Do you have a sub-contractor agreement in place that clearly indicates the worker is an independent contractor?

The old adage regarding a duck couldn’t be more appropriate.  If it looks like a duck, quacks like a duck and walks like a duck- It’s a duck!  Same thing with employees.  If they act like an employee, are treated like an employee and are paid like an employee- they are an employee!

The Employee Definition: The IRS and State Workers Compensation Agencies essentially define an employer/employee relationship as one in which the employer controls the workspace, the hours worked, the equipment to be used and directs the daily and weekly activities of the worker.

A Sub-contractor by contrast is one that typically carries their own tools, supplies, bills for their time and/or services, controls their hours worked and serve multiple customers or clients and aren’t supervised or directed by one employer in particular.

Bottom line, if they are an employee…deal with it and get the proper paperwork and procedures in place. You’ll be far better off in the long run. PLEASE be careful and make sure you discuss this issue with your CPA and attorney when hiring a worker that may be falling within this grey area. This is not a situation you can ignore or take lightly.

Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the new book “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”  and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at

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