Independent Contractors vs. Employees and Why It Matters

We have been asked frequently how to distinguish an independent contractor from a company employee. From the company’s perspective, it matters because the company does not need to provide benefits such as insurance and 401k plans for independent contractors, nor does the company need to pay for taxes such as social security and unemployment taxes. Further more, the independent contractors are much less regulated than regular employees, where the companies need to abide by multiple layers of rules and regulations regarding hiring and firing, vacation policy, etc.

So what are the factors to distinguish employees from independent contractors? What makes some one a contractor vs. an employee? For the IRS, they have a laundry list of factors they consider. Their evaluation is focused on control, behavioral, financial and the type of relationship the two parties have. The state of California has a famous “ABC” test, where they focus on whether the worker is free of the control of the hiring entity, whether the worker performs work outside of the hiring entity’s usual business, and whether the worker has an independent business that’s consistent with the work they are doing for the hiring entity.

Seems complicated. There are lots of good resources, diagrams and checklists about this topic. For simplicity, we have taken the time to draw out the below. Note this is a simplified version for illustration and reference purposes only, and this is not legal advice.

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