Do I Need Workers' Compensation Insurance for Independent Contractors?

Penalties and Fines

The federal government provides strict guidelines to test whether an independent contractor might actually be an employee instead. A company who hires an independent contractor, later deemed an employee in a audit conducted by the government -- state or federal -- must pay back taxes; overtime pay, if incurred; and penalties for classifying someone as an independent contractor when he was really an employee. This results in increased monitoring and continued auditing of the company's business practices over several years with regard to its policy of hiring independent contractors.

The general rule of thumb used by the federal government to tell the difference between an independent contractor and employee is how the company manages the two; clients that hire independent contractor can direct the result of the independent contractor's work, but not what or how the independent contractor completes the work. If the company can tell the worker what to do and how to do it, the government considers that worker an employee. In that case, the worker requires a salary and treatment as an employee, which includes workers' compensation coverage and the same benefits available to other employees.

Other factors to consider in the relationship between an independent contractor and a company is how the financial arrangement between the two is set up. If aspects of the worker's job are controlled by the company, including whether the worker receives reimbursed expenses and the company provides workspace, tools and supplies, then the worker is an employee and not an independent contractor. The worker in this scenario must be covered by workers' compensation insurance.

Under Internal Revenue Service rules, the independent contractor has the ability to direct what work she performs, how she completes it and the periods in which she works -- not the employer. The independent contractor receives payment for work completed without tax withholding. Independent contractors are fully responsible for paying their own taxes, supplies, materials and must provide their own workspace. They must be able to work on their own schedule and not that dictated by a company. The company must, however, provide the independent contractor with a 1099 tax statement at the end of the tax year, which indicates the total amount paid to the independent contractor during the tax year.