Employee or contractor? Getting it wrong can lead to trouble

One of the most damaging mistakes a company can make is misclassifying people who work for it. In the United States, there are two primary classes of workers: employees and contractors. There are substantial differences between the two, and you can get into hot water with the Internal Revenue Service if you pay someone as a contractor, but they should be an employee.

Although we are using the United States as an example, other territories have similar guidelines for classifying workers. Nearly every region requires tax payments. Make sure the tax collector gets their’s.

Companies are responsible for withholding taxes from employee pay and matching those tax contributions. The employer then sends the combined tax payment to state and federal governments. Contractors are required to pay their taxes directly.

Employers are also typically required to pay into a state unemployment fund. They also must contribute to Medicare or pensions and any state- or province-mandated programs (like California’s Employment Training fund). Specifically in the U.S., contractors are not entitled to collect unemployment when out of work unless they pay in separately. Likewise, they may not have access to other programs.

If the government deems that a contractor is misclassified and should have been treated as an employee, the company could be subject to penalties, including back-pay, missed tax payments, and punitive assessments.

Here are questions you should ask to help determine if someone you wish to hire should be an employee or contractor:

Will I dictate where this person works?

Do you require this person to be present in your office to accomplish their work? If so, they are more likely to be deemed an employee. In contrast, contractors are more likely to be able to work from home, a cafe, or anywhere else they choose.

Do I require this person to work specific hours?

If you expect someone to be at their desk from 9 am to 5 pm every day, you’re dictating more of how they accomplish their job. This leans heavily toward employee status. If you’re more concerned with deliverables (specific outcomes required from an employee), you likely have a contractor situation on your hands. Contractors set their own hours, largely work independently, and have specific tasks to accomplish.

Contractors are typically only responsible for getting you the goods (concept art, score, animations, etc.) by a negotiated deadline. If someone is nocturnal, but gets you what you need on time, then you’ve probably engaged a contractor.

Am I expecting this person to work exclusively for me?

If the job takes up an enormous portion of a worker’s time, making the case that they are a contractor will be harder. Likewise, if you demand exclusivity, you are hiring an employee. Contractors typically have multiple clients and aren’t tied to a single company.

How long will my relationship with the person last?

If you want to bring on someone for many months (or years), be careful. The longer a relationship goes on, and the more vital someone is to daily operations, the more likely they should be classified as an employee. In contrast, contractors typically work with clients for discreet periods and then move on. They may team up with you again, but each engagement is often a new contract.

Will I be offering benefits to this person, like health insurance, sick time, or paid vacation?

If the answer is yes, you’re firmly in employee territory.

Will I be supplying a computer, software licenses, or other necessary tools?

Contractors typically provide their own equipment and tools. Employees can reasonably expect that you’ll give them what they need to do their jobs. If you are providing equipment and software, chances are you are working with an employee.

If you run into trouble, the government will look at all of these factors to make a determination about someone’s proper status. There isn’t a specific formula, and all of these elements are considered together to make a determination.

Your best course of action is to consult an attorney and get guidance on this and other employment issues. Many countries’ tax authorities also have online tests you can use to make classification decisions. You can read more about contracts, employee handbooks, and staffing your growing game studio in The GameDev Business Handbook.