How to Know If You Need a W-2 Employee or a Freelancer

PHOTO: Clem Onojeghuo

As a small business owner, making the decision to expand your team is an exciting endeavor that will hopefully lead to greater productivity and profitability. However, this isn’t the only choice an employer has in growing their business.

Before adding a new member to the team, employers must also decide whether to add the new employee as an employee or as an independent contractor. The choice of the appropriate employee title has critical legal and financial implications, including rights and entitlements, for both the employee and the company.

This guide will help small business owners identify before the hiring process whether a W-2 employee or a freelancer is best suited for the position.

The DOL’s “Final Rule” on employment classification

The Department of Labor’s final rule on “Independent Contractor Status under the Fair Labor Standards Act”, also known as the “Independent Contractor Rule”, is a proposal to clarify the “Standard for workers versus independent contractors under the Fair Labor Standards Act”. In the final regulation, which is expected to come into force on May 7, 2021, the ministry names the following main pillars for determining the employee title:

  • The potential for profit or loss of workers based on their level of initiative or the amount of investment made in the work.
  • Type and extent of control over the work.

In addition, if in a particular recruitment situation the two basic pillars of the employee title do not signal the same classification status for a particular employee, the department offers three additional assessment points: 1) whether the work is viewed as part of an integrated production or not unit; 2) the duration of the employment relationship between employee and employee; and 3) the skill level required to perform the job.

The consolidation of the guidelines on employee nomination protects workers’ rights and the independent business ambitions of freelancers. Commenting on the final rule proposal, former DOL Payroll Administrator Cheryl Stanton said, “The streamlining and clarification of the Independent Contractor Identification test will reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility. “

Related article: Should You Hire Contractors to Grow Your Startup?

3 Common Law Factors Used by the IRS to Determine Employee Status

In addition to the DOL rules, the IRS also evaluates and decides on the appointment of employees. Using the IRS Form SS-8, “Determination of Employee Status,” business owners can request that the IRS make a formal decision on whether a particular employee is an employee or an independent contractor – for if the IRS says it is for It is imperative for business owners to properly classify their workers, they mean business.

If an employer incorrectly classifies an employee as a self-employed contractor with no reasonable basis for determination, it can be not only a wage tax liability, but also fines and penalties based on a percentage of wages.

To help business owners decide how to properly classify an employee, the IRS urges employers to consider the following common law control factors that are critical to understanding the differences in an employee or contractor designation:

1. Relationship

How an employee and a worker treat each other is the key to establishing the worker classification. The type of relationship an employee must have with his employer in order to carry out his duties affects the job title of the employee.

When to hire an employee:

  • When the employee’s services are needed long-term or indefinitely.
  • When the work done is critical to the regular operation or success of the business.

When to Use an Independent Contractor:

  • Upon request, services can be completed within a certain period with clear start and end dates.
  • If the company does not intend or deem it appropriate to offer benefits such as insurance, retirement, paid vacation or vacation as part of the recruitment package.

2. Behavioral control

The degree of control an employer has over a worker’s processes and workflows is another important factor in determining employment status.

When to hire an employee:

  • When the worker is instructed on how to do his job, when to work, and what equipment, tools and resources he will use in his role.
  • When ongoing training and assessments are provided to measure the efficiency and success of continued work

When to Use an Independent Contractor:

  • When the work can be adequately carried out under minimal supervision.
  • When the company needs immediate assistance on a project that requires an established, experienced professional with specific expertise, training, or skills.

Related article: Do you want to attract and retain talent? Consider offering these benefits to remote workers

3. Financial control

Financial control is one of the most obvious and important indicators for the designation of workers. Yes, onboarding a new W-2 employee means that the employer is responsible for withholding the employee’s taxes, unlike freelancers who pay their own self-employment taxes via a 1099, but the financial implications for the exact Classification of an employee go beyond tax liabilities. For example, freelancers also have the right to pursue other business opportunities within their available markets.

When to hire an employee:

  • If the company can invest in equipment, the worker has to get the job done.
  • If the employer can reimburse the employee for the expenses incurred in the course of the work.

When to Use an Independent Contractor:

  • When the worker has to provide his own equipment to do the job.
  • If the remuneration for the work is a flat rate, a fixed hourly rate for the duration of the order, a project-related fee or an offer made by the worker and approved by the company.

Not a one-size-fits-all approach to hiring

The decision to hire either a freelancer or an employee cannot be made using a single approach. While every hiring situation is different, all employee titles should be determined using official guidance from the DOL and the IRS, and with additional advice from licensed attorneys if necessary.

Small business owners need to keep in mind that a single factor, including an employment contract, cannot prove freelance status. You need to examine the overall dynamics of work, particularly in relation to elements such as the employer-employee relationship, behavioral controls including supervisory levels, and financial exchanges. When all these factors are weighed, business owners can confidently come up with an appropriate employee designation and add a new W-2 employee or freelancer to their team.

Laura Spawn is the CEO and Co-Founder of Virtual Vocations. Together with her brother, Laura founded Virtual Vocations in February 2007 with one goal in mind: to connect job seekers with legitimate teleworking positions.

June 3, 2021