Breadcrumb

Understanding Independent Contractor Status

Written by

The GoCardless content team comprises a group of subject-matter experts in multiple fields from across GoCardless. The authors and reviewers work in the sales, marketing, legal, and finance departments. All have in-depth knowledge and experience in various aspects of payment scheme technology and the operating rules applicable to each. The team holds expertise in the well-established payment schemes such as UK Direct Debit, the European SEPA scheme, and the US ACH scheme, as well as in schemes operating in Scandinavia, Australia, and New Zealand. See full bio

Last editedJul 20213 min read

It’s important for workers to understand the distinction between an independent contractor and an employee to ensure they’re being treated fairly and lawfully. This has become an especially prevalent issue in the age of the gig economy, with many now working within the virtual marketplace where traditional ideas of employment are challenged.

It’s equally important to know the difference if you’re an employer, as misclassifying a worker can get you in a lot of legal trouble.

What is an independent contractor?

An independent contractor is a self-employed worker who is contracted by an organization or entity to provide a specific service. Known also as a freelancer, an independent contractor isn’t a full-time employee, and is therefore not entitled to employee benefits like healthcare and retirement planning. The specifics of the role or project are outlined in an independent contract agreement negotiated by both parties.

Independent contractor taxes require freelancers to manage their own Social Security and Medicare.

Advantages for independent contractors

An independent contractor typically has more control over their work than an employee – they decide their own hours and working conditions, often being able to negotiate their own timelines and defining their own pay rate.

An independent contractor can take as much work as offered to them – so they can earn as much money as available without being limited by an annual salary. Independent contractors choose their work, so they have the freedom to do what they’re passionate about and simply reject work that doesn’t appeal to them.

There are further benefits that come from being a freelancer, including the elimination of the need to travel to an office every day.

Disadvantages for independent contractors

Independent contractors are not entitled by law to minimum wage, pension schemes, health and dental insurance, overtime pay, and other protections. An independent contractor is also not typically eligible for workers’ compensation or unemployment insurance, as they’re not officially an employee.

OSHA and anti-discrimination laws do not apply to self-employed independent contractors.

In addition to a lack of protections, freelancers face the risk of inconsistent or scarcely available work. An independent contractor has no fixed income, and must therefore rely on whatever contract work is available when they need it.

Furthermore, it’s much easier for an organization to cut ties with an independent contractor than an employee, so freelancing could mean working under more volatile conditions with less job security.

Independent contractors are not protected under the National Labor Relations Act, meaning they are unable to form unions. This has become a contentious issue since the rise of ride-sharing and delivery services like Uber, Lyft, and DoorDash. Drivers for these companies have been classified as self-employed, which has led to a number of major lawsuits nationwide.

The New York Department of Labor had initially deemed Uber drivers to be employees, and the state was sued in July 2020 for omitting unemployment benefits. In August 2020, the California Superior Court determined that ride-sharing drivers cannot be classified as independent contractors, but this ruling was overturned after a proposition put forward by ride-sharing companies was approved by voters.

Ride-sharing drivers are deemed independent contractors in Florida, and as employees in Oregon, Pennsylvania, and Massachusetts.

Legal classification of independent contractors

Both the Department of Labor (DOL) and Internal Revenue Service (IRS) are involved in the classification of independent contractors vs. employees and in defining rights and regulations for each.

Self-employed workers must complete an independent contractor tax form, Form W-9, to confirm their status with the IRS.

State laws for independent contractors may differ from federal laws. In fact, you might be classified as an employee under state law despite being considered an independent contractor under federal law.

There are a number of tests used to determine a worker’s status and it’s important that you check employment status for your specific location. Many states, including Florida and Michigan, use the IRS common law test. Meanwhile, 33 states now use what’s known as the ABC test.

These tests are used to classify employment status based on various attributes, including the amount of control the worker has over their work, whether the role requires a special skill set, the impact of the worker on the company’s overall profits, and more.

Many workers are incorrectly classified as independent contractors, sometimes intentionally so the organization does not have to offer certain benefits.

There are, of course, legal ramifications to this, so whether you’re an employer or a worker, it’s important to understand what separates independent contractors from employees to avoid any trouble. Someone who knowingly misclassifies an employee as an independent contractor might be subject to fines, penalties, or even imprisonment.

We can help

GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.