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An independent contractor is a person, business, or corporation that provides goods or services under a written contract or a verbal agreement. Unlike employees, independent contractors do not work regularly for an employer but work as required, when they may be subject to law of agency. Independent contractors are usually paid on a freelance basis. Contractors often work through a limited company or franchise, which they themselves own, or may work through an umbrella company.
In the United States, any company or organization engaged in a trade or business that pays more than $600 to an independent contractor in one year is required to report this to the Internal Revenue Service (IRS) as well as to the contractor, using Form 1099-MISC. This form is merely a report of the money paid; independent contractors do not have income taxes withheld like regular employees.
The distinction between independent contractor and employee is an important one in the United States, as the costs for business owners to maintain employees are significantly higher than the costs associated with hiring independent contractors, due to federal and state requirements for employers to pay FICA (Social Security and Medicare taxes) and unemployment taxes on received income for employees. Likewise, employees are protected from being fired without cause, and if fired or let go for other reasons are entitled to unemployment benefits, whereas independent contractors have neither protection nor entitlement. Employees are also entitled to receive overtime pay for work performed over the 40-hour-per-week standard, whereas independent contractors may work any number of hours (including far above this standard) with no change in pay.
In the early 1990s, the IRS methodically began to look for employers who were misclassifying employees as independent contractors, and has since obtained billions of dollars in Social Security back taxes. Recently, worker classification initiatives have been a top priority for the IRS, the Department of Labor, and state agencies. In 2011, the IRS and the Department of Labor entered into a memorandum of understanding in an effort to jointly increase worker misclassification audits.
The United States Supreme Court has offered the following guidelines to distinguish employees from independent contractors:
The IRS, for federal income tax, applies a "right to control test" which considers the nature of the working relationship. They highlight three general aspects of the employment arrangement:
In general, their criteria parallel those of the Supreme Court in sentiment. They include guidelines such as the amount of instruction, training, integration, use of assistants, length of professional relationship, regularity of work, location of work, payment schedule, source of funds for business expenditures, right to quit, and financial risk more typically seen with each work category. In their framework, independent contractors retain control over schedule and hours worked, jobs accepted, and performance monitoring. They also can have a major investment in equipment, furnish their own supplies, provide their own insurance, repairs, and other expenses related to their business. They may also perform a unique service that is not in the normal course of business of the employer. This contrasts with employees, who usually work at the schedule required by the employer, and whose performance the employer directly supervises. Independent contractors can also work for multiple firms, and offer their services to the general public.
The distinction between independent contractors and employees is not always clear, and continues to evolve. For example, some independent contractors may work for a number of different organizations throughout the year, while others retain independent contractor status although they work for the same organization the entire year. Other companies, for example in the freight transport industry, specify the schedule for the independent contractor, require purchase of vehicles from the company and prohibit work for other companies.
In July 2015, the U.S. Department of Labor issued new guidelines on the misclassification of employees as independent contractors. "A worker who is economically dependent on an employer is suffered or permitted to work by the employer. Thus, applying the economic realities test in view of the expansive definition of "employ" under the Act, most workers are employees under the Fair Labor Standards Act."
... the economic realities of the relationship, and not the label an employer gives it, are determinative. Thus, an agreement between an employer and a worker designating or labeling the worker as an independent contractor is not indicative of the economic realities of the working relationship and is not relevant to the analysis of the worker's status.
Examples of occupations where independent contractor arrangements are typical:
Independent contracting has both benefits and drawbacks to contractors.
Firms in the sharing economy such as Uber can gain substantial advantages via the misclassification of employees as independent contractors.
The employer of an independent contractor is generally not held vicariously liable for the tortious acts and omissions of the contractor, because the control and supervision found in an employer–employee or principal–agent relationship is lacking. However, vicarious liability will be imposed in some circumstances:
Due to the higher expense of maintaining employees, many employers needing to transition from independent contractors to employees may find the switch difficult. There is a transitional status for employees as an alternative to independent contracting known as being a statutory employee. Statutory employees are less expensive to hire than classic employees because the employer does not have to pay unemployment tax. However, they are more expensive than independent contractors because Social Security and Medicare taxes must be paid on wages. Similarly to independent contractors, statutory employees can deduct their trade or business expenses from their W2 earnings.
A growing number of workers do not neatly fit the government's categorizations of independent contractors and statutory employees, and are increasingly being classified as dependent contractors. Some of these contingent workforce—independent contractors, temporary workers, and part-time workers, who work when and for how long they want, such as those who work for such companies as Uber, Handybook, Inc., and CrowdFlower—have filed lawsuits that argue that companies that substantially control workers' work and behaviors while working (such as at Handybook, Inc.: when to knock on customers' doors vs. ring the doorbells, and how to use the customers' bathrooms) should be covered by minimum-wage and overtime rules under the Fair Labor Standards Act, as well as receive other traditional employee protections. Wilma Liebman, former chairperson of the National Labor Relations Board, has observed that Canada and Germany have such protections in place for contingent workers. And UK Prime Minister David Cameron has appointed an overseer for freelance workers in that country, to determine how the government should support freelance workers.
Many of these companies are built with workers who are not even considered workers at all. In a twist of business logic that drives much of the sharing economy, these delivery people, drivers, and maids aren't employees – they're entrepreneurs.