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Contractors, Subcontractors, and Employees: Why Worker Classification Matters

As a general contractor, you may already know that you must comply with employment laws if you have employees. But what you may not realize is that even if you only hire subcontractors, laborers, and independent contractors, there are certain legal obligations you need to be aware of.

If you're not familiar with these regulations, don't worry. In this guide, we'll cover…

  • The difference between an employee and contractor.
  • The kinds of general contractor insurance you may need to cover employees / subcontractors.
  • Ways you can avoid misclassifications and subsequent legal penalties.
General Contractors: Know the Difference between an Employee and Contractor

General Contractors: Know the Difference between an Employee and Contractor

Generally speaking, hiring contractors involves much less paperwork than hiring an employee. For example, if you hire a contractor, you won't have to pay taxes on their wages like you would for an employee.

Usually, contractors are hired for specific projects, whereas employees complete work on an ongoing basis. Any contractors you hire should work fairly independently. For instance…

  • Contractors should prepare an invoice for you because you aren't responsible for keeping track of their hours.
  • Contractors often use their own tools and equipment.
  • Contractors are responsible for paying their own taxes.
  • Contractors control the manner in which their work is done.

Given that you don't have many obligations to a contractor, it can be a simple way to get the job done.

By contrast, if you hire an employee, you'll have to take money out of every paycheck for federal and (possibly) state taxes, unemployment insurance, and other taxes. You also have to comply with labor laws, such as documenting employee hours, paying overtime wages, and more. (You can learn more in the U.S. Department of Labor's guide, "Compliance Assistance — Wages and the Fair Labor Standards Act (FLSA).")

What Kind of Insurance Do You Need to Cover Employees / Subcontractors?

What Kind of Insurance Do You Need to Cover Employees / Subcontractors?

Regardless of whether you hire contractors or employees, they'll factor into your general contractor insurance.

In most states, you must carry Workers' Compensation Insurance for your employees. Workman's Comp covers legal and medical expenses when employees suffer occupational injuries. Because construction involves a lot of physical risks, Workers' Comp is especially important for your industry. Check your state Workman's Comp laws to ensure you fulfill your legal obligations.

You may need to require that your contractors carry their own Workers' Comp coverage. In some situations, you can be held liable for the injuries your uninsured subcontractors sustain while doing their work. And you don't want that.

Your contractors and subs need to have their own General Liability Insurance, too. If they don't have subcontractor insurance, you can cover them as "Additional Insureds" on your policy. This protects you when a subcontractor makes a mistake that causes property damages or bodily harm and your client sues you for the damages. (Learn more about it here: "Small Business Insurance Basics: What Is an 'Additional Insured?'")

To add your subcontractor to your General Liability policy, contact your insurance agent. When you download your a new Certificate of Liability Insurance, the subcontractor's name will appear in the Additional Insured section.

How to Avoid Misclassification Problems When Hiring Contractors or Employees

How to Avoid Misclassification Problems When Hiring Contractors or Employees

An independent contractor can sue you if they feel they are treated like an employee without the perks of being an employee. If the court agrees that they've been "misclassified," you may owe back taxes, overtime wages, and unpaid benefits.

But how do you know if someone is being treated like an employee?

A few years ago, there was a major lawsuit about this exact issue. In the lawsuit Scantland v. Jeffry Knight, Inc., cable installation contractors alleged they should be considered employees because…

  1. Their work was supervised and they had to follow the installation company's protocol.
  2. They had long-term employment with the company.
  3. They didn't work for any other businesses.

If your contractors meet these requirements, you could face a misclassification lawsuit. In order to qualify as an independent contractor, a party must actually have an independent relationship with the business that hires them. The line between contractors and employees is sometimes a gray area, and each court makes its own decision.

To protect your business, make sure you review the Small Business Administration's guidelines for employers.

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